The %R is very similar to the Stochastic Oscillator. The only difference between the two indicators is how they’re scaled. The %R fluctuates between 0 and -100, while the Stochastic moves between 0 and 100. The Stochastic also has a moving average applied to it so it can be used for “crossover” signals. The Williams %R only has one line by default, although a moving average can be applied to it to give all the functionality of the Stochastic.

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The indicator was developed by Larry Williams, and shows how the current price compares to the highest price over the look back period. Typically the look back is 14 periods; on a weekly chart that is 14 weeks, on an hourly chart 14 hours.

When the indicator is near zero is shows the price is trading near or above the highest high during the look back period. If indicator is near -100, the price is trading near or below the lowest low during the look back period. Above -50 and the price is trading within the upper portion of the 14 period range; below -50 and the price is trading in the lower portion of the 14 period range.

All charts created using http://www.StockCharts.com

Here’s the calculation for the %R:

%R = (Highest High – Close) / (Highest High – Lowest Low) X -100

Where Highest-High is the highest price over the look back period and Lowest-Low is the lowest price over the look back period.

Calculating the indicator is no longer required, as charting platforms and trading software do it for us. Although knowing how the indicator is calculated will help you better understand the indicator and its strengths and weaknesses.

The Williams %R is available on most trading platforms, such as ThinkorSwim and MetaTrader. The indicator is also available on many free online charting sites, such as FreeStockCharts.com, StockCharts.com and Yahoo! Finance.

The most common use for the Williams %R is for “overbought” and “oversold” readings and momentum confirmations and failures.

Overbought/Oversold

A security is overbought when the indicator is above -20, and the security is oversold if the indicator is below -80.

The labels are misleading, overbought doesn’t necessarily mean the price is going to drop soon, and oversold doesn’t mean the price is due for a rally. Prices always reverse at some point, but the overbought and oversold don’t tell us when this will occur. Overbought simply means the price is trading near the top of the 14 day range. Oversold means the price is trading near the bottom of the 14 range. If the price continues to rally or decline, overbought and oversold conditions (respectively) can last a long time.

Traders do use overbought and oversold levels to monitor reversals though. If the indicator is overbought (above -20) and then falls below -50, traders take this as a sign that the price is moving lower. If the price was oversold (below -80) and rallies above -50 traders take this is a sign the price is moving higher.

False signals or late signals occur frequently if these signals are traded unfiltered. Use the price trend to filter the signals.

During a price downtrend, enter short when the indicator was overbought and then drops below the -50 level. During an uptrend, buy when the price was oversold then rallies above the -50 level. The trigger level doesn’t need to be -50, although is the common trigger level used.

Figure 2 shows this approach applied to a stock in an overall uptrend. Only the long trades are taken as the %R moves from oversold to above -50. Since the indicator does not provide a stop loss, one can be placed below the recent low that formed just before the signal (just above recent high for short sale signals).

The same method can be applied to exiting profitable trades. Wait for the price to reach overbought levels (for long trades) then exit when the price falls below -50 (or -20 or -30 to get out a bit earlier). For short trades, let the price move to oversold levels, then exit when the price rallies above -50 (or -80 or -70 to get out a bit earlier).

Momentum Confirmations and Failures

During an uptrend, if the %R continually moves above -20 (overbought) that shows strength and confirms the trend. The price is closing in the upper portion of its 14 period range. It follows that if during an uptrend the %R can’t reach -20, momentum may be failing. If during an uptrend the price falls into oversold territory and then can’t rally back above -20, this shows upside momentum has stalled and potentially reversed.

A downtrend is strong when the %R consistently reaches -80 or below. If it fails to reach -80, momentum is slowing; if it reaches overbought and then fails to drop back below -80, the downtrend could be reversing.

Figure 3 shows how the %R can be used to confirm trends and show failures in momentum. Initially (left side of chart) the price continually reaches above -20, showing very strong momentum. There are barely any pullbacks and they typically stay above -80. If the %R does pullback into oversold territory, it quickly recovers above -20 showing upside momentum is still there.

At the start of March the %R drops and can’t rally back above -20. That is a momentum failure and signals the uptrend is likely over. The %R continually reaching -80 or lower confirms this, and shows the downtrend is strong. Not until late May when the %R moves above -20 is the downtrend drawn into question.

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Just using %R for entries will produce a large number of false signals; false signals are when the indicator signals that the trend is turning, but in fact it doesn’t. Only taking signals in the same direction as the trend can help in this regard.

Exits are also an issue. At times the traditional exit will get you out of the trend too early. The third trade (from the left) in Figure 2 is an example of this. After the entry the price moves into overbought territory and then drop below -50 signaling an exit, yet the price continued to move higher for three more months.

The trend can also help in this regard. As long as the price is making overall higher swing highs and higher swing lows, maintain your long positions (ignore exit signals). When the price stops making higher highs or higher lows, then get out the next time the %R drops below -50.

Figure 4 shows the significant difference this can make during a strong trend, such as the trend that was originally shown in Figure 2.

The same principle is applied to downtrends. Hold short positions as long as the price is making lower swing lows and lower swing highs (ignore exit signals). When the price stops doing this, get out the next the price moves above -50.

The Williams %R is a trading tool, not a complete strategy. Placing stop losses and coming up with your own exit strategy, such as the one described above, is required.

The creator of the indicator is Larry Williams, a commodities trader born in 1942, and author of 11 books. In 1987 he won the (real money) World Cup Championships for Futures Trading with an 11,376% return in 12 months—the highest return ever in the competition . His daughter, Michelle Williams (who is also an actress), won the competition in 1997 with a return of 1,000%. Whether the Williams %R played a pivotal role in helping them accomplish these returns is unknown.

The %R is used in various capacities, including overbought/oversold levels and momentum failures. It can also be used to provide trade signals and let you quickly know where the price is in the context of the look back period. It moves between 0 and -100 and is very similar to the Stochastic which moves between 0 and 100. Since the indicator moves and forth between “overbought” and “oversold” it is prone to providing false signals. Using the indicator in conjunction with other indicators or price and trend analysis will help filter out some of the false signals.

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