Originally published at: https://optimusfutures.com/tradeblog/archives/trade-channel-rebounds-overbought-io/
The Overbought IO indicator (OBIO) for MetaTrader 5 is a proprietary technical indicator that can be applied in various markets and market conditions. In this article, we explore how to trade channel rebounds with Overbought IO and mold it in a way that would make its application practical for any technical trader looking to add on to or enhance their existing trading methodology.
The OBIO channel rebound is a conspicuous and a fairly repetitive market phenomenon where price shows deliberate attempts to move rapidly away from the middle band to approach either the upper bands or the lower bands and then sharply rebound off of them.
Like a fake breakout, this move, when looked at with a combination of other factors, can serve as a trap for many traders, with the sharp rebound off the bands acting as the ultimate confirmation of a potential move in the opposite direction.
The chart above illustrates some of these scenarios. You will see how price rapidly moves towards the red or the green bands and use them as support or resistance to rebound sharply off of them. These bands, which have been derived from conventional bands, work in a way similar to the traditional indicator but have been modified to be less lagging and more reactive to price moves.
You will also note that each of the occasions marked on the chart above where price tried to pierce the bands necessarily resulted in a sharp bounce. While extremely common, we would like to assert here that it obviously is not a guaranteed outcome every time. In certain market conditions (especially during sideways trading conditions) the bands may be violated several times without the market completely reversing off the bands – or at times not reacting to the bands at all.
This is where the idea of confluence and the extended part of technical analysis and knowledge of price action dynamics and behavior come in. By itself, the touch of the bands may not be a powerful signal at all, but when combined with other OBIO factors or general technical analysis implications, weak signals can quickly be filtered further to decide on a direction breakout.
Let’s take a look at a few of these factors:
The OBIO dots (yellow and red) work efficiently to highlight specific overbought/oversold (in case of yellow dots) or extremely overbought/oversold (in case of red dots) that will often appear timely at the impact point on the bands that price touches.
A market rapidly accelerating towards the upper bands and a red dot appearing at the touch of the green bands can be an indicator that the market has entered a strongly overbought territory and is therefore possibly likely to rebound off the impact point.
The chart above illustrates a viable example. Notice how we have a red dot right at the time that the market touches the top bands, giving us an early hint that the market just entered overbought territory, therefore making the sharp move down.
Horizontal support and resistance is likely the most fundamental technical analysis tool used almost universally by all technical traders, regardless of their trading style or method. OBIO’s application makes no exception. Using side to side support and resistance, as well as angular support and resistance trend lines via visual aids can be as a tool for confluence as you can find to validate your channel rebound entry points supplied by the OBIO.
Taking the same example from above we can illustrate how we had more reasons to believe that price could potentially bounce off the upper bands.
As you will note, the area lined up with a horizontal resistance (depicted by the faint yellow rectangle on the chart above) area as well as a descending resistance trend line.
The momentum shift indicator, which as the name suggests is a barometer of sentiment strength in the market, can be a indicator to spot bullish and bearish divergence to make a strong case in favor or against a potential channel rebound trading opportunity.
Ideally, for a higher quality setup, you would prefer to see supporting divergence displayed by a mismatch between highs and lows on the Momentum Shift indicator and actual price action.
As in the chart above, we see a bearish pin bar coming right off the upper bands along with bearish divergence on the Momentum Shift indicator. We also have added confluence from the facts that we have a resistance area in the same zone as well as a timely red dot displaying overbought characteristics.
The actual entry and exit criteria with OBIO triggers remains highly discretionary and can be molded to fit the individual trader’s trading style and risk appetite.
Traders typically like to enter either at the close of the impact candlestick (the candlestick that first pierces the bands) or ‘blindly’ via a pending order at the bands awaiting price to touch and trigger it. These are aggressive approaches because they do not rely on waiting for evidence suggesting a bounce. Occasionally price can also continue to trot along the upper bands as momentum continues resulting in either a delayed bounce or no bounce at all.
To avoid falling prey to these pitfalls, it is best advised to follow a more conservative approach which relies on waiting for supporting price action before entering the market. These methods include waiting for appropriate candlestick patterns (engulfing patterns, pin bars, dojis etc.) or waiting for the Middle Band Break (MBB) that is, waiting for the market to return to and break the middle band. The flipside to these approaches is that they can often result in delayed entries or entirely missed entries (for example where the market rebounds immediately after hitting the bands and does not present any price action confirmation at all).
Stop loss and take profit levels can also be subjective amongst traders with the OBIO. Many traders prefer to tuck their stop losses either a few ticks above (or below) the bands to factor in continued momentum, while others just tuck their stops behind price action confirmation candlesticks or patterns. Take profit levels can either be trailed manually or automatically (since this is a momentum trading approach) or set fixed at a nearby area of support or resistance.
Stoploss Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders
Trading indicators on their own do not generate gains. Your experience, discipline and market conditions may prevent you from having any financial benefits. The Overbought IO method’s goal is to assist traders in developing an approach that can potentially build a foundation for trading that is not based on hunches, gut feel or intuition. We do not claim that the overbought IO components are the only tools necessary for successful trading. Your experience, skills and your developed method can potentially help you.
All statements in this publication is our opinion. These are our own interpretation of the markets and could be the opposite of other experts who build their own method. Our opinion is not a universal truth, rather interpretation of the markets the way we view it.
Risk Disclaimer: The development of Overbought IO method is based on what we considered some of the essential elements in trading, but we cannot possibly encompass all the variables necessary, especially when each trader finds different variables for trading based on his/her risk tolerance.
Trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition.
USE ONLY RISK CAPITAL. You should never put yourself or your family in a position of risk and trade capital you cannot afford to lose.
The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.
The high degree of leverage that is often obtainable in commodity interest trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. Please consider if trading in leveraged products fits your own risk profile.