Dow Jones ($INDU) Chart with %R Indicator – December 7, 2007

I changed the look of my DJIA chart a little this weekend.  I’ve added in the momentum indicator Williams %R (aka %R).  %R tries to measure overbought and oversold levels.  The 0-20 and 80-100 levels are highlighted in grey automatically.

Stockcharts.com goes into greater detail, but here’s a snippet:  

William %R, sometimes referred to as %R, shows the relationship of the close relative to the high-low range over a set period of time. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. The nearer the close is to the bottom of the range, the nearer to -100 (lower) the indicator will be. If the close equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the close equals the low of the high-low range, then the result will be -100 (the lowest reading).

What I’m highlighting below is the wide range of time a stock or in this case, an index, can trade in the overbought and oversold areas.  The red boxes show the overbought periods and the blue boxes show the oversold periods.  The purple box shows the importance of the time period you choose to review.  I used 14 and 28 day indicators.  The 28 day smooths out some of the peaks and valleys seen in the 14 day indicator, but for the most part they travel close to each other.

The reason I’m going into this today is to try to dispell some of the fear that we are already overbought.  The 28 day %R hasn’t even gotten there yet and what’s more important is when it leaves the overbought/oversold areas.  Had you sold everything when the DJIA crossed into the overbought area in each of the red boxes you would have missed a few hundred points of profits.  The same goes for the blue boxes if you had bought back everything to soon.  Again, watch for the exit points from these extreme zones, not the entry points.

Last, but not least, I only drew one trend line this week (in part because it was cluttered enough).  That single line shows where the DJIA broke through what appeared to be a new downward trend.  Also, for the past two days, the DJIA closed above its 10, 20 and 50 day moving averages for the first time since the end of October.  That’s certainly bullish.  I’m leaving my sentiment indicator to slightly bullish until after the Fed announcement this week.  I was off the low by a couple of days, but still seem to have gotten the direction right in the two weeks following.