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: October 17, 2021
: Prashant Shah
We plot indicators on the price chart to read momentum and identify extreme zones. Usually, what happens is stocks may remain in an overbought zone for a long period during strong uptrends. They can also remain in the oversold zone for a while during a strong downtrend.
Extreme zones are well respected when the market is in a sideways range-bound phase. Hence, oscillators or indicators moving between a particular range are more useful in a sideways or range-bound market. In simple words, Overbought and Oversold zone are more useful in a range-bound market.
Oversold zone helps in identifying stocks witnessing bullish pullback pattern during strong uptrend and overbought zone helps in identifying stocks witnessing bearish pullback pattern during strong downtrend. Stocks in overbought zone are rather more in bullish in uptrend, hence they should not be called as overbought. Same way, stocks in oversold zone are more bearish during downtrend.
I am introducing an interesting indicator called PMOX. It stands for Price Momentum with O and X. It is calculated using the XO zone and the number of boxes in a recent swing pattern.
PMOX indicator oscillates between 0 and 100 with above 75 and below 25 being the extreme zones. When the indicator moves above 75 and the price is in a strong uptrend, it means that the price is in a bullish momentum zone. In this case, a green dot is marked and the uptrend is expected to continue.
When the indicator moves past 75, but if the trend is not strong, it is considered an overbought zone. In this case, a red dot is marked and a trend reversal is expected.
When the indicator falls below 25, but the trend is bearish, it indicates strong bearish momentum. A red dot indicates that the trend is expected to remain bearish.
When the indicator falls below 25, but the trend is not bearish it becomes an oversold zone and presents an opportunity to look for a bullish strategy. In this instance, a green dot is marked and the trend is expected to reverse.
Hence, a green dot above 75 shows a strong bullish momentum. The green dot below 25 shows an oversold zone in a bullish trend. Similarly, a red dot below 25 shows strong bearish momentum while a red dot above 75 indicates an overbought zone in a downtrend.
• Green dot above 75 shows bullish momentum
• Red dot above 75 shows Overbought
• Red dot below 25 shows bearish momentum
• Green dot below 25 shows oversold
The indicator is created by combination of multiple indicators such as XO zone, pattern counter and various trend following indicators and oscillators.
It identifies strong trend and changes the color of dot accordingly.
This indicator is a combination of momentum and oscillator indicators that helps in identifying the trend. The overbought and oversold zones identified by the indicator can help in timing the entries in the short term. Bullish column reversal pattern after the oversold zone and bearish column reversal pattern after the overbought dots are reversal patterns. The double- top buy pattern after the bullish momentum dot and the double-bottom sell pattern after the bearish momentum dot are continuation patterns.
Have a look at below chart.
Point A and B are Green dots below 25 that shows oversold zone. They indicate strong market even though the pattern was bearish double bottom sell. The bullish signal or even a bullish column reversal after these occurrences can be a nice opportunity to initiate the bullish trade. In zone C in the above chart, there are multiple green dots showing bullish momentum.
There are many ways to use this indicator. It can help in identifying strong pullback candidates as well as stocks in strong momentum. You can use it in your trading system and create various systems by using system builder feature in the TradePoint Web and Desktop versions.
You can also perform multi-timeframe market analysis using this. A simple way to do this is to go to TradePoint -> Scanner -> Smart Scanner -> PMOX Multi-timeframe scanner.
It will show PMOX zone on three different box-values. 0.25% box-value is recommended for short-term, 1% for medium-term and 3% for long-term. The comment will be Overbought for red dot above 75, oversold for green dot below 25, bullish momentum for green dot above 75 and bearish momentum for red dot below 25.
It will look like this.
You can identify the pattern on a particular timeframe and analyse the chart for higher timeframe.
A technique to identify strong oversold zone is when the instrument reaches Oversold zone in 0.25% and 1% timeframe and it is in bullish momentum on higher timeframe. Have a look at below scanner image for recent example of that.
HCLTECH in above example is in oversold zone in short-term and medium-term and it is in bullish momentum on long-term.
DALBHARAT is in oversold zone in short-term and medium-term and setup is not bearish on higher timeframe.
We can look for pullback opportunities in such stocks.
Simply, oversold zone on 0.25% and not bearish setups on 1% and 3% are also good reasons to look for bullish trading opportunity.
The risk-reward in pullback trades is usually decent. Exactly opposite is applicable for overbought zone.
How about writing puts if you see liquid option stock in oversold zone? Remember, overbought and oversold of PMOX takes trend into account. There are many possibilities using this indicator. It is a very sensible and logical indicator applicable on all types of market phases and adapts itself to the changing market scenario.
Though the indicator is created using important properties of P&F chart, the candidates can be traded on any other charting method. The indicator is also applicable on relative strength charts and introduced in my recent book ‘Outperforming the markets using Relative Strength and Breadth analysis’.