The Overbalance strategy is one of the most fascinating technical analysis techniques, focusing on trend analysis, especially the study of correction ranges in a given trend. In the basic Overbalance method, we compare the ranges of new corrections to the largest correction that has occurred so far. If the new correction significantly exceeds the range of the largest one, we can talk about a probable point of trend reversal.
Typical Correction Range
The original Overbalance method lacks a reference point if corrections in the current trend are not too deep. Another larger correction may not disrupt the structure of the current trend, which often happens when the trend is just forming. Moreover, in periods of lower liquidity, corrections can be reversed, and the upward impulse can last longer. Therefore, it is worth modifying the basic approach slightly and talking about the typical range of corrections, adopting their permissible range. You can also use additional indicators, such as moving averages, to more precisely determine whether we are dealing with a trend reversal.
Trading with the Trend
On the GBPUSD H4 chart, we can see how to trade based on the Overbalance strategy. In this case, the continuation of the trend was not negated due to the formation of a larger correction but rather due to the exhaustion of demand and the lack of strength to create another higher peak. The chart also shows the usefulness of moving averages as a confirming indicator. All corrections after the largest one end above the 50 SMA, suggesting that the market may try to create another higher peak if it turns above the average.
Entering Trades
There are two main approaches to entering trades using the Overbalance strategy. The first involves taking a long position when the current correction reaches around 80-85% of the largest correction so far. The second approach involves shifting the analysis to a lower timeframe and looking for the moment when the trend structure changes to an upward one. Both approaches have their pros and cons. In the first, we risk that the market will continue to fall, and in the second, we may rush and enter the position too early. It is reasonable to combine both methods, entering a trade after the trend reversal on a lower timeframe but not earlier than after a 70% retracement of the largest correction.
Stop Loss (SL): Set at -120% retracement of the largest correction, meaning if the current correction exceeds the largest one by 20%, SL should be another 20% lower.
Take Profit (TP): Set below the last peak.
Trend Reversal
A signal of a possible trend reversal is when a correction in an uptrend is significantly larger than the previous largest correction. If its course is decisive, it may indicate that investors are starting to take profits. In the chart above, we see four equal boxes and a fifth exceeding the previous ones by 20-30%. The trend has been ongoing for some time, we are clearly above the 200 SMA, and the last box resulted from a correction consisting of large bearish candles. After moving below the 50 SMA, the attempt to continue the uptrend is practically unsuccessful, and the price cannot even breach the average.
Conclusion
The Overbalance strategy is a valuable tool in every trader's arsenal, especially those preferring a technical analysis approach. While this method is not free from flaws and challenges, its simplicity and effectiveness make it often used in practice. Integrating it with other
Comments