How to identify a trend reversal and enter the market at the right time?

An oversold or overbought market is something that occurs quite often. Traders look for these situations because if they occur, there is an increased possibility of a trend reversal and the emergence of a new trend. As you already know, jumping on a trend at its beginning, and trading it for its entirety, is the goal of the vast majority of traders. But before we get into how to recognize this type of market, let's talk about what overbought and oversold are.

What is an overbought and oversold market?

An overbought market occurs when the price of a particular asset, such as a stock, commodity, or currency pair, has risen to a level that appears to be too high based on various technical indicators and historical price movements. In an overbought market, there is usually a strong and sustained rise in the price of an asset. However, nothing lasts forever, and when the price starts to approach levels of significant resistance or historical highs, a downward reversal of the price, or trend, can be expected.

As you might guess, the opposite is true in an oversold market. That is, the price of the asset is too low, approaching historical lows or significant support levels, and thus an upward reversal can be expected.

The impact of trading psychology

The market is shaped by its human participants who, as such, are to some extent controlled by emotions. Emotions play a big role in trading and although countless publications have been published on the subject of suppressing them in trading, even the greatest professionals cannot always manage to do so.

So if we look at an oversold and overbought market through the lens of psychology and emotions, an interesting picture emerges. An overbought market is often influenced by excessive euphoria over price rises and greed, manifested in traders buying more and more. Conversely, the oversold market is dominated by fear and pessimism.

From the euphoric to manic behavior of investors and traders in an oversold market, the atmosphere in an overbought market is diametrically opposed. Investors and traders sell their positions for fear of further price declines and try to abandon the sinking ship. This only deepens the panic, which leads to further sell-offs. But all this is being watched from afar by value investors and bargain hunters. And so a change in trend is on the horizon...

The market is a constant battle between buyers and sellers, and at some point, the balance has to move in the opposite direction. And that is exactly the situation that experienced traders are waiting for. The less experienced can take advantage of the Purple Extreme indicator, which can identify an upcoming breakout in an overbought/oversold market.

Purple Extreme Indicator - a great helper in identifying trend reversal

The Purple Extreme indicator looks for the extreme market situations described above in the form of a strongly "oversold" or, conversely, a strongly "overbought" market. The indicator itself is very easy to understand and use. Thanks to the Purple Extreme Indicator, you will get a great overview of when the market price has reached its probable peak or, on the contrary, bottom. If we can use these situations well in trading, they can bring us potentially very profitable trades.

How to use the Purple Extreme Indicator

The indicator is composed of three different parts. Once the yellow line is in the blue-green part of the indicator, there is a strong uptrend in the market. At the same time, however, it can indicate a possible trend reversal and therefore the beginning of a downtrend. However, such a situation may not occur immediately. It is always better to wait for confirmation when the yellow line leaves the overbought blue-green part and starts heading downward. In this case, it is possible to consider entering the trade.
 

• The white part of the indicator means a neutral zone when the side of buyers and sellers is relatively in equilibrium. Zero, intermittent line means the break-even point to determine the moment when the buyers are going to prevail (white zone above the zero line), or when the sellers are going to prevail (white zone below the zero line).

• Breaking above/below the zero line may be used, theoretically, as a signal for opening or closing any trade in case of optional use of this indicator or as an additional filter for any other indicator.

• If the yellow line is found in the red part of the indicator, there is a dropping trend in the market. At the same time, it may mean a potential trend reversal, so a start of a new rising trend. However, such a situation does not have to occur immediately. It’s always better to wait for a confirmation when the yellow line leaves the oversold part and starts to move upwards. In such a case, it’s possible to consider the opening of a trade.

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_{The black circles here show the points when it is potentially appropriate to open a trading position.}

When to use the Purple Extreme indicator and when to avoid using it

However, please remember, that the Purple Extreme indicator is not infallible. If the yellow line leaves the extreme zone (the green-blue and the red one), it does not always mean that the trend is changing! Especially, if this is a market that tends to experience frequent and long trends. Conversely, the Purple Extreme indicator is very appropriate to be applied to the major forex pairs that often change their direction of price movement, so none of the sides (buyers and sellers) can be that dominant here for a long time.

Of course, the Purple Extreme indicator may be used also in any other way that may be appropriate for your trading strategy. For example, it may be freely combined with other indicators or used as a filtering element for your trading strategy based on the Price-Action principle. So, there are no limits set in this case se and you can include the Purple Extreme indicator as another element in your trading arsenal.
 

How to set the Purple Extreme indicator

Purple Extreme indicator contains also some user settings you can change according to your will. Here is the list of them:

• Extreme period - here, you will set the indicator’s period, so how many candles, going back to the history, the resulting value is going to be calculated form. Example: If there is a value of 20 set here, the Purple Extreme indicator will take the last 20 candles into account and evaluate the actual situation in the market according to this. The default and recommended setting is 20.
• Oversold: Level - the indicator value may be found within a range from -100 to +100. The -100 value means an extremely oversold market while the +100 value means an extremely overbought market. The oversold Level shows the pre-set level of an oversold part. So, which value will be considered as a deviation from the normal? The default and recommended setting is -70.
• Oversold: Color - color of the oversold zone. The default color is red.
• Overbought: Level - the indicator value may be found within a range from -100 to +100. The -100 value means an extremely oversold market while the +100 value means an extremely overbought market. Overbought Level shows the pre-set level of an overbought part. So, which value will be considered as a deviation from the normal? The default and recommended setting is +70.
• Overbought: Color - color of the overbought zone. The default color is green-blue.

How to put the Purple Extreme indicator into operation

1. Turn on (run) our Purple Trading MT4 trading platform

2. At the top, on the left side, click on the "File" and choose "Open Data Folder"

3. Open the "MQL4" file and then, the "Indicators" file

4. Insert the downloaded file (indicator) into the "Indicators" file

5. Turn off and on (again) our Purple Trading MT4 trading platform

6. Now, the Purple Extreme indicator is ready for use

Tutorials for Windows and MAC operating systems with screenshots you can found on our website.
 

How the Purple Extreme Indicator works - watch the video

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