How to filter good and bad entry signals? TD REI and TD POQBITFINEX:BTCUSD
Dear friends!
I continue describing Thomas DeMark’s technical tools.
Today, I am going to deal with more DeMark’s technical tools, TD REI and TD POQ that are included in the group of indicators TD Oscillators.
Major problem of all oscillators
The main problem that DeMark sees in the use of oscillators is that average traders exaggerate the value of the divergence of the indicator with the price position.
As a rule, people, who do not understand how an indicator works and based on what principle it alternates, do not care what the composition and the recommended interpretation of this indicator might be. They try to interpret its vague signals that aren’t basically signals and must be confirmed by other indicators. A good example is a famous indicator, RSI.
In May, this indicator showed a bearish divergence in the daily timeframe (see the chart above) and, according to all rules, the trend should have reversed, and the price should have started declining. According to DeMark, the main problem in interpreting such signals is that users do not take into account the time that the indicator is in the overbought and oversold stages. DeMark notes that if the indicator is in the overbought or oversold zone for more than 6 bars, this indicates the strength of the trend, which means that this signal is false.
It is clear from the above chart that the two overbought zones lasted for more than 6 bars, which indicates the trend’s strength, and so, the oscillator’s correction in these cases will be a false sell entry signal.
The number of bars may be different for other oscillators. Everything depends on the indicator’s parameters and the peculiarities of its composition. Therefore, in each particular case for each timeframe, one should perform an own analysis of the number of bars in the overbought or oversold zones.
To facilitate the analysis of all these parameters, DeMark developed his own series of oscillators that will described below.
Introduction to TD REI indicator
First, I’d like to write about TD REI, or Range Expansion Index. This indicator is designed to filter out false signals when the price is trading in the range or in a strong trend, it should send a reversal signal only if the market sentiment really changes.
Before I present the charts with this indicator, I want to pay tribute to its developer @ e2E4mfck. The matter is that the TD indicators are not available in the Tradingview standard library, therefore, I had to look for those that were published in the public library and only thanks to such enthusiastic programmers can you get acquainted with these wonderful tools by DeMark.
So, you see the TD REI indicator in the chart above, at its bottom. The TD REI oscillator typically produces values of -100 to +100 with 45 or higher indicating overbought conditions and -45 or lower indicating oversold. Besides, the TD REI counts the number of bars, and, if the price is in the overbought or oversold area for more than 6 bars, the indicator shows this and indicates a strong trend.
On the other hand, this indicator is more responsive to the price changes, and, while the RSI is still in the overbought area, or in the neutral area, the TD REI has already a few times entered the oversold area, thus sending a buy signal (in the above chart, all buy signals on the indicator are marked by circles, and by green flags on the price chart.
It stands to reason that this indicator is much more complicated than it may seem, based on the above example. It also has many peculiarities, which I will describe later.
First, I’d like to describe its mathematical model, so that you can understand the indicator’s signals.
Mathematical model of TD REI indicator
The TD REI value is calculated by adding the respective differences between the current day’s high and the high two days earlier and the current day’s low and the low two days earlier.
To make it clearer, the calculation formula looks like this:
X = (H – H2) + (L – L2), where
H is the current high
H2 is the high two days earlier
L is the current low
L2 is the low two days earlier.
Besides, two conditions must be met:
Condition 1
• the current day’s high must be greater than or equal to the low five or six days ago,
or
• the high two days earlier must be greater than or equal to the close seven or eight days ago.
Condition 2
• the current day’s low must be less than or equal to the high five or six days ago
or
• the low two days earlier must be less than or equal to the close seven or eight days ago.
If neither of the conditions is met, a zero value is assigned to that day’s bar.
If both conditions are met, then there will be a different formula:
TD REI = (Y / (H5 - L5)) x 100
Where:
Y = (Sum X1 next… X5)
H5 is the high over a five-day period
L5 is the low over a five-day period
Differently put, TD REI a kind of shows the price movement, adjusted to a trading range over the five days.
TD REI filter for signals
Like any other indicator, TD REI is not a Grail and sends false signals too. To filter out these false signals, Thomas DeMark suggests using the TD POQ indicator, (Price Oscillator Qualifier).
To be fair, I must note that this indicator can be used together with any oscillator, based on the price action, (for example, MACD, RSI).
TD POQ conditions to validate the TD REI signals:
Buy signal:
1. TD REI has been in the oversold condition (below -40) for six or more bars;
2. The last complete bar should close below than the previous bar
3. The current bar’s open should be equal or lower than the highs of the previous two bars;
4. The market should be trading above the open price and break through the high iver the last two days.
Sell signal:
1. TD POQ has stayed in the overbought condition (above + 40) for six or more bars;
2. The last complete bar should close higher than the previous bar’s close
3. The current bar’s open should be equal or higher than the low for over the last two days
4. The market should be trading lower than the opening price and break through the low of the last two bars.
To explain how you can use the TD POQ to filter the entries, I’ll describe the examples of a buy and a sell signal.
Buy signal:
1. It is clear from the chart above that the first condition is satisfied, the price has been in the oversold area for more than 6 bars.
2. The last complete bar closed lower than the previous bar’s close (green dots below the red ones in the chart)
3. The current bar opens lower than the highs of the two previous bars (the current opening price is the same as previous bar’s close, it is market with green dots; and it is lower then the two yellow dotted lines)
4. When the price breaks through the highs of of the last two bars, there is a buy signal (it is marked with the red cross).
As you see from the chart, there is a reliable early signal to enter a trade.
I must note that the TD REI is a good supplementary tool for other Thomas DeMark's indicators. It is clear from the above chart that the signal perfectly matches to the start of a bullish set, indicated by TD Sequential (the developer is @andyhitchman) on the five-day timeframe (but it also matches on the shorter timeframes).
Sell signals
Now, let us analyze the sell signal on the example of the BTCUSD all-time high.
First, I’d like to note that the TD REI indicator, starting from 8000 USD recorded on November 20th, 2017 (in the BTCUSD price chart) was in the overbought condition for more than 30 bars and has never sent a false sell signal! In my opinion this fact alone is the evidence of the TD REI efficiency.
Now, let us analyze the sell signal produced on December 19th.
1. As I’ve already said that the indicator had been in the overbought zone for than 6 bars before the signal emerged. We can put a check.
2. The last candlestick closed as a doji, the closing price is almost equal to the previous bar’s close. This condition is NOT fully met, so we need an additional confirming signal.
3. In the above chart, you see that the current bar, of December 19th, opens lower than the high of the previous two days, so, we also put a check.
4. The market broke through the lows of the previous two bars and is trading lower (I marked the breakout with the red cross).
Therefore, as there is not a fully confirmed signal, it is important to employ this indicator with other Thomas DeMark’s tools.
For example, in the previous article (see here), I described a good tool, TD Propulsion.
In that article, we defined the TD Propulsion Up Target level for the bullish trend at level 18286.4 USD.
If we attach it to the present chart and add the calculations of the TD Sequential indicator, we shall see that this very bar closes lower than the TD Propulsion Up Target level, and at the same level, a bearish set up starts, based on the TD Countdown indicator.
Both these signals are confirming signals and, finally, suggest sell trades.
Analysis of the BTCUSD current market situation
Now, let us analyze the current BTCUSD price trend. In the previous article, when I was writing about the TD Trend Factor and TD Propulsion indicators, I finally outlined three possible scenarios for bitcoin trading.
At that time, it was difficult to determine the BTCUSD future trend.
Remember, there were three scenarios:
1. BTC price should rebound from level 12172.9 USD and go down
2. The price should rebound from level 14202.4 USD and be trading flat with a possible decline in future
3. The BTCUSD should continue moving up.
Now, if I apply the TD REI with the TD POQ filter to this chart, the situation becomes clearer.
As you see from the above chart, the last TD REI signal satisfies all the four conditions of the TD POQ filter (the overbought condition continues longer than six bars, the last bar’s close is higher than the previous bar’s close, the current bar’s open is higher than the lows of the two previous bars and the lows of those bars have been broken through).
In addition, as the fourth condition suggests, the market was trading lower than the reversal bar’s open (blue dots). Therefore, the first scenario, a more pessimistic one, becomes more likely. As I wrote in the previous article, the BTCUSD price is likely to hit the TD Propulsion Up level (level A). In fact, the market has already worked out this target so far, having not reached just a few dollars. Considering the bullish set up on the five-day timeframe, according to the TD Countdown, the btcusd may be trading flat for some more time. The BTCUSD may even try to hit level again 12172.9 USD, but, in general, it is not enough to invest your entire deposit into entering a buy trade.
As experience proves, the combination of TD REI signal and the TD POQ is a strong signal and I don’t recommend ignoring it. The BTC price is likely to rebound and continue its downward correction, according to the pessimistic scenario. After all, it doesn’t suggest that the bullish trend will necessarily end. However, my overview of the TD REI indicator won’t be complete if I don’t describe a situation, when the TD POQ filter doesn’t work.
The above chart represents such an example. You see that the TD REI has been in the overbought area for a long time, however the reversal bar (marked with the red arrow) doesn’t satisfy the last condition, the bar doesn’t break through the lows of the previous two bars. It is clear from the above chart, that the price hasn’t reached the level, marked with blue dots.
It suggests that the sell signal is false, and so, when the indicator reaches the oversold area, one might use this opportunity and enter a new buy trade, to increase the bullish position (I marked the buy zone with a green flag in the chart).
In case of a bearish trend and an unconfirmed buy signal, one may act in a similar way. However, you must always bear in mind that it is better to employ DeMark’s tools together. Only when all the indicators send the same signal, you can avoid trading mistakes and safely put entries.
I am not finishing writing about Thomas DeMark's oscillators. In my next educational posts, I am going to describe such indicators as:
TD DeMarker,
TD Pressure,
TD Range expansion Index,
TD Rate of Change.
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I wish you good luck and good profits!
Mikhail @Hyipov
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