Technical Analysis—Indicators that Identifies Overbought and Oversold levels

In [1], Victor Dergunov has used the below indicators to identity $SPX overbought levels:

• Commodity Channel Index (CCI)
• Relative Strength Index (RSI)
• Full Stochastic Oscillator

In this article, we will use the same indicators to look at EWY (iShares MSCI South Korea Capped ETF NYSE).

Figure 1.  EWY chart on 11/08/2019

Relative Strength Index (RSI)

Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. According to Wilder, RSI is considered overbought when above 70 and oversold when below 30. Signals can also be generated by looking for divergences, failure swings and centerline crossovers. RSI can also be used to identify the general trend.

EWY (11/08/2019)

• On 11/05/2019, the RSI was over 70 and now is back to 66.40.

Commodity Channel Index (CCI)

Commodity Channel Index (CCI) is a versatile indicator that can be used to identify a new trend or warn of extreme conditions. Lambert originally developed CCI to identify cyclical turns in commodities, but the indicator can be successfully applied to indices, ETFs, stocks and other securities. 

In general, CCI measures the current price level relative to an average price level over a given period of time. CCI is relatively high when prices are far above their average, but is relatively low when prices are far below their average. In this manner, CCI can be used to identify overbought and oversold levels.

The Commodity Channel Index (CCI) can be used as either a coincident or leading indicator.

Coincident Indicator

As a coincident indicator, surges above +100 reflect strong price action that can signal the start of an uptrend. Plunges below -100 reflect weak price action that can signal the start of a downtrend.

Leading Indicator
As a leading indicator, chartists can look for overbought or oversold conditions that may foreshadow a mean reversion. Similarly, bullish and bearish divergences can be used to detect early momentum shifts and anticipate trend reversals.

Full Stochastic Oscillator

When stocks trading in ranges, they are well suited for the Stochastic Oscillator.  There are three versions of the Stochastic Oscillator available on stockcharts.com. 

• Slow Stochastic Oscillator
• Fast Stochastic Oscillator
• Full Stochastic Oscillator (Full STO)

Here we will cover only Full Stochastic Oscillator (Full STO).

The Full Stochastic Oscillator is a fully customizable version of the Slow Stochastic Oscillator. Users can set the look-back period, the number of periods for slow %K and the number of periods for the %D moving average. The default parameters were used in these examples: Fast Stochastic Oscillator (14,3), Slow Stochastic Oscillator (14,3) and Full Stochastic Oscillator (14,3,3).

When Full STO dips below 20 warn of oversold conditions that could foreshadow a bounce. Moves above 80 warn of overbought conditions that could foreshadow a decline. Notice how the oscillator can move above 80 and remain above 80 (orange highlights). Similarly, the oscillator moved below 20 and sometimes remained below 20. 

The indicator is both overbought AND strong when above 80. A subsequent move below 80 is needed to signal some sort of reversal or failure at resistance. Conversely, the oscillator is both oversold and weak when below 20. A move above 20 is needed to show an actual upturn and successful support test.

EWY (11/08/2019)

• On 10/10/2019, the Full STO moved above 80 and remained above 80 until now (current: 83.09).

References

1. S&P 500: Don't Get Too Comfortable, A Meltdown Could Occur At Any Moment
2. S&P 500 Reaches Extreme Overbought Levels (08/15/2022)