The OverBought IO indicator, or ‘OBIO’ for short, is a proprietary technical indicator developed by seasoned traders over years of trial and error and testing, building a professional trading methodology around market momentum and price action. This article will break down the indicator and provide a step by step approach to understanding and using the OBIO indicator in day to day trading for potentially improved trading process.
We begin by describing and discussing the components of the indicator.
The Three Pillars of OverBought IO
The OBIO is essentially made up of three key components:
1) The Overbought and Oversold Channels
These are the two red overbought channel lines you see above price and the two green oversold channel lines below price. The inner lines are channels that can potentially help you identify strong trends early and possibly also allow you to ride these trends for longer. The outer lines denote extreme overbought and oversold levels which can potentially help you identify possible reversal areas and market tops and bottoms.
On the chart above, you will notice that sometimes these channels are dotted with different colors. These dots can serve as entry triggers as we will later discover in the article.
2) The Momentum-Shift Histogram
At the bottom of the chart, you will find the Overbought IO Momentum-Shift (MS) histogram. Taking the lead from some conventional histogram style indicators that are known for providing lagging and often delayed signals, the algorithm behind the MS indicator runs at pace with market movements and may identify divergence and potential turning price points. We will go more in depth explaining the MS histogram later in the article.
3) MFT – Trend Info Box
The Trend-Info box, located at the top left corner of the chart, lays out critical multi-time frame information, eliminating the need to switch between time frames for a birds-eye view or a narrowed down view for added perspective.
Top-Down, multi-time frame analysis is the foundation of any successful trading approach in our opinion, and developments on a single time frame can sometimes lead traders into ignoring other higher or lower time frame perspectives. This is where the MFT Trend-info box comes in handy, displaying market sentiment across various time frames.
The Utility of OBIO and Application
Although primarily being a momentum-based indicator, the OBIO can effectively be applied in different markets, volatility and periods.
Let’s take a deeper look at these market scenarios.
Day and Swing Trading
The Overbought IO indicator is an auto-adjusting trading framework that works equally well on higher and lower time frames. This means that the underlying calculations and algorithms automatically adjust based on price data distribution on that particular time frame. Thus, you can use the OverBought methodology as a day trader on the lower time frames or as a swing trader on the higher time frames without running into compatibility or consistency issues. Later, we will explain how to distinguish between high and low probability trading scenarios so you can make the most of your OBIO indicator in different trading conditions. There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.
The versatility of the indicator also means you can adopt a hybrid trading style covering aspects of both; day and swing trading using OBIO. An example would be taking swing trades with the help of the indicator in swinging conditions and jumping down time frames for shorter-term intra-day trades when higher time frames appear to be indecisive and consolidating. Again, we will look at specific trade examples later in the article.
Now that have you a better understanding of the individual components of the Overbought IO indicator, we can explore how to use the indicator to make actual trade decisions and how to use it to find the best trades and signals possible.
There are five potential signals in particular, and by combining them, you get a robust trading methodology. Please be aware that any one sign is usually not enough to justify a trade entry, but the trader who understands each signal and combines them in meaningful ways has a robust trading strategy at his hands. We will walk you through each signal now.
Now let’s discover actual trading scenarios with the OBIO.
Channel Violation and the Dots
The first most obvious and common signal is when price violates (or pierces) through the outer channel bands, followed by an immediate move back into the channel; these spikes are often accompanied by orange or red dots that show up above (for bearish price action) or below (for bullish price action) actual price movement.
The orange and red dots point to highly overbought price violations and extremely overheated trends – mainly when they occur after a long trending period. Orange and red dots are strength signals, and you’ll see that they often work as standalone signals reasonably well.
The yellow dots in comparison indicate early warning signs of trend exhaustion and are therefore weaker indicators of a potential momentum and typically do not foreshadow reversals, but we will explore scenarios where yellow dots can be combined with other signals to form trade ideas. The primary function of the yellow dots is to raise awareness that the current trend is firm but that it may be shifting soon.
The divergence on the Momentum-Shift (MS) indicator is another compelling way of identifying trends that are likely to come to an end or approach a consolidation/pullback phase. A divergence exists if price makes a higher high, but the MS indicator does not make a new high. In the case of a bearish divergence, the price makes a lower low, but the MS indicator makes a higher low.
Just like conventional divergence, the Momentum Shift indicator signals that although the price is maybe making new highs and lows consistent with the ongoing trend, momentum within that trend may be slowing down.
Divergence can happen frequently, and it’s important to look for divergences only after strong trending periods . A big mistake many traders make is that they look for divergence too soon and then try to call reversals in the middle of a strong trend – we will show you how Overbought IO will help you deal with such issues.
Types of MS-divergence:
(1) The Swing divergence: This is where price spends some time between creating the two highs/lows. The two divergences on the right in the screenshot below are what we call swing-divergences.
Especially significant are swing-divergences that are accompanied by an orange or red dot (or dots). As you can see from the screenshot below, the lows of the first swing-divergence each had a red dot, and it predicted the future strong reversal. In the case of the second swing-divergence, there were no dots and price did not reverse, but just entered a sideways consolidation and ended the trend. Past performance is not indicative of future results.
(2) The Grind-divergence: This is where price immediately makes lower lows or higher highs. On the chart below this can be seen to the far.
The grind-divergence we have highlighted below showed a series of yellow dots which indicate that price was constantly trading under overbought conditions, but that the trend was still going on. You can also see that the MS indicator reversed sharply from red to green – another signal we will explore soon.
Middle Band Break
The middle band break (MBB) is a confirmation signal that adds even more weight to a developing trading scenario, especially after a channel violation or an MS divergence. The MBB allows us to combine what we have previously learned about the channel violations and the deviations to find signals and time trade entries.
The screenshot below shows some typical Overbought IO trades where the MBB played an essential role in confirming the best trade entries. You can see that price alternated between bullish and bearish trends, going up and down.
From time to time, you might get signals from Overbought IO (in the form of dots or divergences) that may point to a reversal. However, waiting for the MBB is a way to time entries well when used as an entry trigger. The annotations in the chart below show how the dots, the divergences, and the MBB could have been combined to find solid trade entries at very early stages of fledgling trends.
Quick MS Shift across the Zero Line
The MS indicator, in contrast to conventional indicators such as the RSI, the Stochastic or the MACD, is not a lagging indicator. The MS reacts very quickly to moving price and is super-efficient when it comes to finding shifts in sentiment. The MS can recognize changes in buyer-seller sentiment. This also means that crossover of the histogram bars above or below zero can be taken much more seriously and when added with other sources of confluence.
When the MS quickly shifts from red to green or vice versa, it shows a substantial shift between bullish and bearish sentiment. This signal is even more critical when it is accompanied by an orange/red dot and a divergence. When you find such a scenario, you could potentially expect a robust reversal.
From time to time, you might get signals from Overbought IO (in the form of dots or divergences) that may point to a reversal. However, waiting for the MBB is a way to time entries well when used as an entry trigger. The annotations in the chart below show how the dots, the divergences, and the MBB could have been combined to find trade entries at very early stages of a trend formation.
Channel Squeeze and Breakout
Since the OBIO indicator is a momentum indicator, and it does share some traits with other momentum indicators commonly used to identify tight trading conditions.
Narrowing, or squeezing channels, usually predate active breakouts and new trends. Such behavior is especially common on lower timeframes where periods of dull trading activity or indecisive sentiment can be quickly overtaken by strong buying or selling resulting from a technical breakout or perhaps a news event. The OBIO allows you to take advantage of these situations.
However, where traders are extensively looking for breakout scenarios, there is always the fear of being trapped in a false breakout situation as well. The OBIO is not immune to the drawback but can make it visually appealing when try to identify opportunities of such breakouts.
Fake Breakout Channel Squeeze
This is a widespread market behavior you will often find right at the end of a squeeze mimicking an actual breakout that never happens. The screenshot below shows a few of those false breakouts. In the case of a bullish trend, you will often see an initial spike lower, then usually an immediate reversal into the opposite direction to create a new pattern. The OBIO can sometimes help spot these situations by printing an orange or a red dot just at the breakout point hinting at the possibility of a quick reversal.
In the chart below you will see how using the OBIO frequently in your day to day trading decisions can help you spot repetitive patterns linked to false breakouts that you could potentially avoid.
Filtering out Bad Signals
Successful trading is not only about knowing when to trade, but also when not to trade. No system works 100% of the time and understanding when you should stay out of the markets is an important skill that all successful traders have mastered. Here are 3 OBIO scenarios that should be avoided because they can lead to low probability trading signals.
Large Candlesticks Closing At or Beyond the Outer Channels without Other Signs of Weakness
If you are using the Overbought IO framework mainly to find swing patterns that lead to new trends around the outer overbought and oversold levels, you have to avoid high momentum trending periods. This means that when the price is showing large candles with small wicks that move close to the first channel line, it is better to avoid reversal signals during those times. Remember that reversals can be materialized during fading momentum or when you see a price spike; however, when you look at high momentum price action close to the outer bands, this usually signals a strong trend. With practice, you will learn how to distinguish between a strong market and a market that is showing fading momentum.
Violations of the Middle Band and Tight Congestions
We have talked about how the MBB can be a good indication of market sentiment and a potential entry trigger for your trades, but be wary of these middle band breaks during periods of consolidation and when the outer channels are squeezed together showing tight trading activity.
Tight congestions that happen around the middle band are low probability trading scenarios where you likely don’t have an edge. This is especially important for traders on the lower time frames (1h or smaller) where tight congestions happen frequently. Always wait for clearly defined price swings and defined ranges with well-defined boundaries.
Trading during tight congestions is not only harder because of misleading and inaccurate signals; it can also lead to emotional and impulsive trading because of the constant changes in direction and altered analysis viewpoints.
Take Lead from Higher Time Frame Direction
Trading with the higher time frame trend is important because it usually makes for much smoother trades. The MFT trend info box shows you whether the direction on the higher timeframe is up or down; it even shows you how reliable the trend is on the higher time frame and how far price has already moved. The Trend-Info box also shows you if the price has exceeded its daily projected price target or if it still has more room to go. Thus, you can use the Trend-Info box to get a sense of direction and avoid trades that violate the higher time frame trend.
The more aggressive traders can also choose to trade against the higher trend but should be prepared to manage their positions more closely and exit sooner than trades that go with the overall direction.
Application – Developing a Complete Method
We have shown you different ways and techniques to identify trading signals, and you have also learned which market conditions to avoid. Now, we will go even more profound and show you how to create a complete trading methodology by combining conventional technical analysis with the Overbought IO framework.
Support and Resistance
Overbought IO can be combined effectively with traditional support and resistance. Support and resistance is a simple, yet the useful concept of technical analysis and when combined with the Overbought IO trading methodology, can be even more powerful and effective.
In the context of the Overbought IO principles, support and resistance act as an additional filter. Instead of looking for OBIO signals across the entire chart, fine-tuning entries on locations surrounded by visible side to side support and resistance levels can be a way to find trading opportunities.
Other forms of support and resistance like double tops and double bottoms can also work great with OBIO. You should start paying attention to orange/red dots that exist around those areas, channel squeezes and MS divergences.
Price Action and Formations
Price action and price patterns are also important ways to add confluence to your trading scenarios. Especially kangaroo tails, inside bars, engulfing bars and head and shoulders are important patterns that can improve the quality of your signals.
The two screenshots below show two such scenarios where a price action signal or pattern added additional confluence to the regular Overbought IO signals.
Other OBIO Strategy Parameters
The OBIO indicator is just a technical indicator that can easily be molded to any trading system or method. However, given the principles and factors above it should not be hard to build a standalone trading system hinged on the OBIO indicator itself. Let’s discuss the important aspects of setting stop losses and take profits for an OBIO-centered trading strategy.
Stop-Loss 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.
Setting the Stop Loss
With the Overbought IO framework, setting stop-loss orders is straight forward, and we keep it as simple and effective. Here are the main points you need to follow when it comes to setting your stop loss.
(1) Always set the initial stop loss outside of the outer bands and, to be on the safe side, add some extra room to the stop loss. That way your trade is not as vulnerable to sudden volatility.
(2) Once the trade moves in your favor, trail the stop behind you to protect potential gains. There are two ways of trailing. Firstly, you can use the outer band for your stop trailing as a conservative approach. A more aggressive approach could entail a tighter stop loss that you want to peg to the middle band.
Take Profit Placement
With the Overbought IO methodology, there are two ways to could go about profit placement and we will explore them now.
(1) Target the opposite outer band
Trading price from one side of the outer channel to the other is the “conservative” way and it’s ideal for traders looking for a set-and-forget objective trading style.
(2) Letting the Trade Run
This method does not use pre-set take profit orders, but it aims at riding large trends for as long as possible, taking lead from the ongoing price action and latest developments. A trader who follows this method also runs the risk of stopping out the trader during tighter consolidation phases.
The OBIO Indicator in a Nutshell
While we are very confident about OBIO indicator and its vast application to technical analysis, we do not believe that it is a fool-proof, so called “Holy Grail” method that will automatically guarantee great results as soon as it is installed and applied on your charts.
It is a powerful method with objective criterions for profitable trading that traders with all experience levels should find easy to work with, but we by no means guarantee your success with the OBIO. Like all other methods, the OBIO also demands practice and sufficient chart time as well as a sound understanding of market rhythms and price action as a necessary prerequisite for success with this unique indicator. For traders willing to put in the effort to learn and apply the OBIO, we are confident that it will be a great addition to their trading arsenal.
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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 involve 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.