Technical analysis Technical indicators

The Effectiveness of the Signal of Overbought and Oversold

Elena Berseneva 16 February 2022 338 4

Oscillators are listed among the most popular indicators among traders. The reason for their attractiveness is the ease of identification of trading signals that they offer.

 

Traditionally marked out are several types of signals that are derived from the following oscillators:

 

  • divergence;
  • the crossover of moving averages with various parameters;
  • the exit of the signal line of an oscillator from the overbought/oversold zones.

 

In our study, we suggest examining the last of the listed types of oscillator signals: «overbought and oversold». And we explore this signal with a complex approach by using several popular oscillators in our analysis at once.

 

The boundaries of these relative zones are conventionally denoted by the levels of 20 and 80 on the vertical scale of the oscillator. A sell signal is formed when the oscillator rises above the overbought line, then reverses, and crosses it in the upward direction. A buy signal is formed when the oscillator falls below the oversold threshold and then crosses it up.

Hypothesis
To conclusion

A signal which was formed at the exit of the oscillator line from the zone of overbought/oversold is profitable.

К выводам


In our research, we examine the following widespread oscillators:




Technical indicator
Indicator parameters
Author of the system
Reversals from the overbought/oversold zones
Money Flow Index (MFI)
Period: 14
Bill M.Williams
If the price is above the level of 80 reversed in the overbought zone and broke the level of 80 top-down, we sell it. Buy signals are reverses of the level of 20.
Relative Strength Index (RSI)
Period: 14
J. Welles Wilder
 
Tops of the Relative Strength Index are usually formed above 70 and bottoms are below 30, and they usually outrun the top and bottom formation in the price chart.
Moving Average Convergence/Divergence (MACD)
Rapid EMA: 12;  slow EMA: 26; SMA: 9. By closing prices.
Gerald Appel
When the short moving average rises significantly above the long moving average (i.e. when the MACD grows), this means that the price of the considered instrument is probably considerably overpriced and will soon return to a more realistic level.
Stochastic Oscillator
Periods: 5 and 3. Slowdown: 3. Prices: low/high.
George Laing
Place a buy order when the oscillator first falls below the level of 20 and then rises above it; Place a sell order when the oscillator first rises above the level of 80 and then falls below it.
Commodity Channel Index (CCI)
Period: 14. By closing prices.
Donald Lambert
The Commodity Channel Index usually fluctuates in the range between   ±100. Values which are above +100 indicate the overbought state (and a possibility for a corrective downturn) and values which are below -100 indicate the oversold zone (and a possibility for a corrective upturn).
DeMarker
Period: 14
Thomas DeMark
When the values of the DeMarker indicator falls below the level of 30, an upward reversal of prices is expected. When the value of the indicator rises above the level of 70, a downward reversal of prices is expected.
Williams' Percent Range
Period: 14
Larry Williams
The indicator’s values in the range between -80% and -100% indicate the oversold state. Values in the range of 0% to -20% indicate that the market is overbought. Place a buy order when the oscillator first falls below the level of -80 and then rises above it; Place a sell order when the oscillator first rises above the level of -20 and then falls below it.


In the charts, the overbought/oversold zones of oscillators look like in the following way (the bottom window in the picture):

Formation of a buy signal:

Indicator [2] < Oversold (Indicator in the oversold zone)

Indicator [1] > Oversold (Indicator gets out of the oversold zone)

 

Formation a sell signal:

Indicator [4] > Overbought (Indicator in the overbought zone)

Indicator [3] < Overbought (Indicator gets out of the overbought zone)

 

We will test the reviewed signals against a large amount of historical data of various financial instruments and on the basis of two timeframes.

 

Now, we specify conditions of the opening and closing of a trading position.

 

The opening of a position:

When a signal is formed, a position opens at the opening of a new candlestick:

  • An exit from the oversold zone bottom-up is a buy signal;
  • An exit from the overbought zone top-bottom is a sell signal.

 

The closing of a position:

The lifetime of the position is set at 5 or 10 (in candlesticks) in all cases. 

Data used

Let us specify the list of financial instruments and their timeframes against which we will carry out the test of trading signals.


This sample will be represented by:

  • 23 currency pairs (Forex);
  • 5 commodity futures (Commodities);
  • 2 stock indices (Indices);
  • 30 stocks (Stocks).


Timeframes used:

  • H1 (1 hour): the history for the period of 5 years,
  • D1 (1 day): the history for the period of 10 years.


The sample is 2 101 235 values.

Having specified all the conditions and set necessary parameters, we can start testing!



The analysis of the obtained results

 

First, we will estimate the results based on the sample size.


For the H1 timeframe (1 hour):


Indicator
Market segments
Number of candlesticks
Number of events
MFI
Forex
994755
23145
Commodities
172240
7063
Indices
87600
2946
Stocks
628011
9166
RSI
Forex
994755
30315
Commodities
172240
5517
Indices
87600
2940
Stocks
628011
19609
Stochastic
Forex
994755
91787
Commodities
172240
17292
Indices
87600
8633
Stocks
628011
64339
CCI
Forex
994755
134635
Commodities
172240
22865
Indices
87600
11590
Stocks
628011
83952
DeMarker
Forex
994755
67354
Commodities
172240
11603
Indices
87600
5983
Stocks
628011
40799
WPR
Forex
994755
135461
Commodities
172240
22672
Indices
87600
11449
Stocks
628011
84088
MACD
Forex
994755
52047
Commodities
172240
8905
Indices
87600
4509
Stocks
628011
32976



For the D1 timeframe (1 day):


Indicator
Market segments
Number of candlesticks
Number of events
MFI
Forex
83950
1728
Commodities
18250
302
Indices
7300
152
Stocks
109129
1259
RSI
Forex
83950
2465
Commodities
18250
514
Indices
7300
228
Stocks
109129
3263
Stochastic
Forex
83950
8459
Commodities
18250
1981
Indices
7300
801
Stocks
109129
11408
CCI
Forex
83950
11573
Commodities
18250
2544
Indices
7300
1042
Stocks
109129
15107
DeMarker
Forex
83950
5413
Commodities
18250
1126
Indices
7300
459
Stocks
109129
7145
WPR
Forex
83950
11391
Commodities
18250
2584
Indices
7300
969
Stocks
109129
15500
MACD
Forex
83950
4462
Commodities
18250
970
Indices
7300
379
Stocks
109129
5857



The total number of candlesticks and events with two timeframes together:


Indicator
Number of candlesticks
Number of events
MFI
2 101 235
45 761
RSI
2 101 235
64 851
Stochastic
2 101 235
204 700
CCI
2 101 235
283 308
DeMarker
2 101 235
139 882
WPR
2 101 235
284 114
MACD
2 101 235
110 105



Then, we discover the share of events in % in the total number of initial candlesticks with two timeframes together:


Market segments
MFI
RSI
Stochastic
CCI
DeMarker
WPR
MACD
Forex
2.3
3.0
9.3
13.6
6.7
13.6
5.2
Commodities
3.9
3.2
10.1
13.3
6.7
13.3
5.2
Indices
3.3
3.3
9.9
13.3
6.8
13.1
5.2
Stocks
1.4
3.1
10.3
13.4
6.5
13.5
5.3
Average
2.7
3.2
9.9
13.4
6.7
13.4
5.2


As the result of grouping, we can conclude that irrespective of market segments, the distribution of events under our consideration is almost the same for every oscillator.

 

Now, we turn to the results of performance of trading signals obtained through oscillator exits from the overbought/oversold zones.

 

We will assess the results with the two following criteria:

  • Momentum (m) reflects the average change in quotes of financial instruments at the moment of fixating a position, in %. A positive value of the momentum indicates profitability of the signal performance, a negative value indicates loss-making.
  • SPP, the share of profitable positions, %.

 


The Momentum in %, the Share of profitable positions in % on a term-to-term basis of the hold of positions and timeframes:


Indicator
Indicator
5 candlestick
10 candlestick
H1
D1
MFI
m
-0.044
-0.024
-0.048
-0.020
SPP
48.9
48.9
48.3
49.5
RSI
m
-0.062
-0.125
-0.071
-0.116
SPP
48.1
48.0
48.5
47.6
Stochastic
m
0.006
0.006
-0.021
0.032
SPP
49.2
49.3
49.0
49.6
CCI
m
0.014
-0.011
-0.019
0.022
SPP
49.5
49.3
49.2
49.7
DeMarker
m
0.004
-0.034
-0.045
0.015
SPP
49.3
48.8
48.7
49.4
WPR
m
0.000
-0.020
-0.031
0.011
SPP
49.4
49.2
49.0
49.5
MACD
m
-0.038
-0.053
-0.048
-0.043
SPP
49.1
49.3
48.7
49.6



The Momentum in %, the Share of profitable positions in % on a basis of market segments:


Indicator
Indicator
Forex
Commodities
Indices
Stocks
MFI
m
-0.014
0.012
0.076
-0.064
SPP
48.8
48.3
47.6
49.2
RSI
m
-0.017
-0.268
0.063
-0.134
SPP
48.5
46.8
47.6
48.0
Stochastic
m
0.019
-0.030
0.012
0.001
SPP
49.3
49.3
47.2
49.3
CCI
m
0.011
-0.001
0.011
-0.006
SPP
49.6
49.9
47.7
49.3
DeMarker
m
0.015
0.051
-0.006
-0.050
SPP
49.9
49.2
48.2
48.5
WPR
m
0.018
-0.030
0.020
-0.030
SPP
49.5
50.4
48.2
49.0
MACD
m
0.000
0.032
-0.008
-0.096
SPP
50.0
50.2
47.9
48.5



We can identify some peculiarities:

  • Fixating a position at the 5th candlestick is more profitable/ less loss-making for all oscillators but the MFI;
  • The trading signal over the daily timeframe is more profitable/less loss-making for all oscillators but the RSI.

 

Let us examine the results on a term-to-term basis of the hold of positions and timeframes.

 

We take the following notations:

«H1 / 5», the position fixation at the 5th candlestick over the 1-hour timeframe;

«H1 / 10», the position fixation at the 10th candlestick over the 1-hour timeframe;

«D1 / 5», the position fixation at the 5th candlestick over the 1-day timeframe;

«D1 / 10», the position fixation at the 10th candlestick over the 1-day timeframe;

m, momentum, %;

SPP, the share of profitable positions, %.

 

 

The Number of signals, the Momentum in %, and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes, and market segments (the MFI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
9166
2946
7063
23145
42320
Momentum
-0.068
-0.003
-0.052
-0.009
-0.042
SPP
48.3
50.2
46.5
48.4
48.3
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
9164
2946
7062
23143
42315
Momentum
-0.089
-0.005
-0.036
-0.015
-0.054
SPP
48.5
50.4
47.5
48.4
48.4
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
1259
152
302
1728
3441
Momentum
-0.137
0.171
0.006
0.040
-0.047
SPP
49.1
46.3
48.9
50.6
49.5
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
1259
152
301
1726
3438
Momentum
0.036
0,140
0.130
-0.072
0.006
SPP
50.8
43.5
50.4
47.9
49.4



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (the RSI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
19609
2940
5517
30315
58381
Momentum
-0.090
0.012
-0.037
-0.002
-0.048
SPP
47.7
49.9
49.4
48.8
48.4
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
19606
2940
5517
30308
58371
Momentum
-0.170
0.009
-0.115
-0.001
-0.094
SPP
47.9
49.3
49.2
49.6
48.7
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
3263
228
514
2465
6470
Momentum
-0.088
0.139
-0.363
-0.017
-0.076
SPP
48.9
47.4
44.1
47.5
47.9
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
3257
228
513
2455
6453
Momentum
-0.187
0.091
-0.557
-0.049
-0.156
SPP
47.4
43.8
44.5
48.1
47.3



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (Stochastic):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
64339
8633
17292
91787
182051
Momentum
-0.023
-0.001
0.003
-0.003
-0.012
SPP
48.7
48.8
49.6
48.9
48.8
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
64327
8633
17289
91769
182018
Momentum
-0.056
-0.010
0.002
-0.003
-0.029
SPP
48.8
48.6
50.3
49.3
49.1
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
11408
801
1981
8459
22649
Momentum
0.024
0.054
-0.019
0.030
0.024
SPP
50.2
45.7
48.2
49.3
49.6
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
11402
799
1978
8445
22624
Momentum
0.058
0.006
-0.107
0.052
0.040
SPP
49.6
45.6
49.1
49.8
49.5



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (the CCI):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
83952
11590
22865
134635
253042
Momentum
-0.007
-0.004
0.011
0.000
-0.003
SPP
49.0
48.8
49.3
49.4
49.2
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
83927
11590
22861
134621
252999
Momentum
-0.070
-0.013
-0.005
0.001
-0.036
SPP
48.8
48.8
49.4
49.7
49.2
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
15107
1042
2544
11573
30266
Momentum
0.047
0.096
-0.007
0.014
0.032
SPP
50.2
49.0
50.2
49.5
49.9
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
15093
1040
2542
11554
30229
Momentum
0.007
-0.034
-0.001
0.027
0.013
SPP
49.4
44.0
50.5
49.8
49.4



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (DeMarker):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
40799
5983
11603
67354
125739
Momentum
-0.065
-0.005
-0.021
0.001
-0.034
SPP
48.2
49.3
48.0
49.4
48.7
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
40792
5981
11600
67348
125721
Momentum
-0.111
-0.010
0.003
-0.002
-0.056
SPP
48.1
49.3
48.7
49.3
48.7
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
7145
459
1126
5413
14143
Momentum
0.047
0.165
0.022
0.028
0.041
SPP
49.4
50.6
49.3
50.7
49.9
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
7138
458
1125
5400
14121
Momentum
-0.070
-0.173
0.201
0.032
-0.012
SPP
48.1
43.5
50.6
50.0
48.9



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (WPR):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
84088
11449
22672
135461
253670
Momentum
-0.039
-0.003
0.020
-0.002
-0.019
SPP
48.6
49.5
50.3
49.0
48.9
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
84075
11447
22669
135444
253635
Momentum
-0.088
-0.009
0.011
-0.001
-0.044
SPP
48.6
49.1
50.8
49.3
49.1
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
15500
969
2584
11391
30444
Momentum
0.013
0.142
-0.059
0.033
0.019
SPP
49.8
49.6
49.7
50.0
49.8
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
15484
966
2582
11371
30403
Momentum
-0.007
-0.052
-0.093
0.043
0.004
SPP
49.0
44.4
50.5
49.7
49.2



The Number of signals, the Momentum in % and the Share of profitable positions in % on a term-to-term basis of the hold of positions, timeframes and, market segments (MACD):


Н1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
32976
4509
8905
52047
98437
Momentum
-0.095
0.001
0.009
0.002
-0.046
SPP
47.7
48.5
50.0
49.4
48.6
Н1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
32974
4509
8904
52035
98422
Momentum
-0.099
-0.011
-0.004
0.000
-0.050
SPP
48.3
48.0
50.2
49.4
48.9
D1/5
Stocks
Indices
Commodities
Forex
All
Number of signals
5857
379
970
4462
11668
Momentum
-0.074
0.017
0.074
0.002
-0.030
SPP
48.9
48.3
50.5
50.6
49.7
D1/10
Stocks
Indices
Commodities
Forex
All
Number of signals
5851
379
970
4457
11657
Momentum
-0.115
-0.037
0.048
-0.004
-0.057
SPP
48.9
46.8
49.9
50.7
49.6



Let us summarize the obtained results using the following diagrams:

The highest momentum of 0.041 % is shown by signals of the exit from overbought/oversold zones obtained with the DeMarker oscillator over the 1-day timeframe with the position fixation at the 5th candlestick.

 

The lowest momentum of -0.156 % is indicated by signals of the exit from overbought/oversold zones obtained with the RSI oscillator over the 1-day timeframe with the position fixation at the 10th candlestick.

 

In general, the momentum of exit signals from the overbought/oversold zones of all oscillators under our consideration is low. So, we can mark the considered signal as ineffective.  

Conclusion

So, trading signals generated by an exit of oscillators from overbought/oversold zones are ineffective.



The influence of the exit of oscillators from the overbought/oversold zones on the market has not been identified.

Detailed results are shown in the Appendix:

XLSX (0.10 MB)Application to the article 'Overbought and oversold in oscillators_ Let's check the effectiveness of a popular signal'.xlsx.xlsx

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