What it is:
Often combined with stochastics to detect overbought and oversold conditions, Williams %R -- or %R for short -- is a momentum indicator developed by Larry Williams.
How it works (Example):
Using stochastics in combination with %R is a valuable way to confirm overbought or oversold conditions in order to help guide successful trading activity.
Based on a 14-increment period, the calculation of Williams %R is:
(highest high over 14 periods - today’s close) / (highest high over 14 periods - lowest low over 14 periods) * (-100)
The Williams %R value ranges between 0 and -100, with -80 and below indicating oversold conditions, and -20 and above indicating overbought conditions.
While stochastics compares the close of a security/index to its lowest low over a specific time period, Williams %R compares the close to its highest high over a specified period. Usually this time period is in increments of 14, as in 14 days, weeks or months. However, the period can change depending on the sensitivity of the timeframe you want to trade.
With increased buying pressure, a strong security can become and stay overbought for long periods. Likewise, with increased selling pressure, a weak stock/index can become and stay oversold for long periods. Therefore, stochastics is best examined in conjunction with bullish or bearish divergence, which shows momentum changing direction before price.
In contrast, Williams %R alone often accurately anticipates price reversal in and of itself. The indicator tends to form a triangle-like peak, then almost immediately reverses course. Price reversal tends to follow very shortly thereafter.
Because full stochastics uses a smoothed moving average, the indicator tends to anticipate changes more slowly than Williams %R, which often gives a quicker signal.
Williams %R tends to be more responsive to overbought/oversold conditions. However, because it gives more frequent signals it can be less reliable than stochastics. Combining the two indicators can help create a more reliable analysis.
Why it Matters:
Observing Williams %R or stochastics in relation to overbought or oversold levels can help determine when to best enter or exit a trade. When the two indicators are used in combination, the analysis can be that much more powerful.