Overbought/Oversold for currencies

[SG]

I was wondering if anyone has considered this thought process (which is probably a bit warped and overly philosophical). Especially since many indicators seem to miss measuring overbought and oversold.

My thought is this. Stocks, for example, have a value that can be calculated and therefore, a stocks price can be greater or less than that value. I know there can be a disconnect in the price of the stock that is being traded and that price relative to financially calculated values such as book value, etc. But all in all, there can be price mismatches that indicate it is either overbought or oversold. This would make sense to use an indicator on a chart to show if it is overbought/oversold relative to a perceived value of the price on a chart.

But currencies on the other hand, don't really have "value" per se (unless you want to get into things like parity between countries currencies), so does it make sense, and do you think it may make using overbought/oversold indicators on charts for currencies? I know indicators by their very nature are lagging, which is an issue for stocks as well. So if we are trying to determine overbought/oversold for a currency, what value would it be relative to? The banks are the ones who will determine what a currencies value will be anyway; of course based on a variety of factors which include swaps for their corporate / government clients, carry trades, etc. But as retail traders, I believe the banks somewhat use this type of information against us, which kind of makes these types of indicators useless.

Does anyone have any thoughts about this? Are there any articles that I could be directed to that may offer evidence that indicators that were initially created for stock trading can be applied the same way for currencies if the underlying dynamics are different?

Thanks

 

[AndrewS]

Have you looked into purchasing power parity? I also think it is a mistake to believe a stock has "a" value. Yes there is a strong relationship between earnings and price but we have see stocks that have no earnings become quite expensive and the market is always looking at future rather than current earnings anyway. There is also the issue of price to earnings ratio. At different times people are willing to pay vastly different multiples for an earnings number. In fact much of the price change in markets is due to that purely psychological phenomenon. Bull markets are the result of people willing to pay rising P/E ratios and bear markets are the opposite.

 

[Marcas]

Agree with AndrewS. Value of a stock is very relative. We can repeat after Buffet sentence comparing value and price to weighting and voting but there is big problem with this approach and if you like philosophical approach you can have some fun with it.
Same with currencies. If you assume that stocks have any kind of value you must conclude that currencies have it as well, although you calculate it different way.
Even if you manage to construct your overbought/oversold indicator I bet it wont be much better than any other out there.

 

[SG]

Hi Andrew & Marcas,

Thank you for your comments

I guess I didn't make myself understood (which is not unusual). I was not thinking about constructing an overbought/oversold indicator, but rather wondering about its usefulness for currencies as opposed to an instrument like stocks. I understand purchasing power parity which is why I mentioned it in the original post as "parity" ... but just didn't feel like writing the whole thing out. I know currencies tend to gravitate towards this value over the long term and obviously when central banks make a statement, they definitely risk disrupting that apple cart. I also understand how PE ratios can enter the picture and how that is used frequently to indicate whether the market is fairly valued relative to history and also regarding tech stocks which can / have traded without any perceived earnings (a.k.a. the dot com bubble).

My post was probably more of a philosophical one, on one hand, but also from a purely technical analysis indicator standpoint; are the use of OB/OS indicators such as stochastic's that do have some use in stocks (except of course the lag of the indicator), useful for evaluating OB/OS in currency pairs? I also wonder if this may or may not be the case because of the huge part that banks play in the movement of currencies. Since they control more than 90% of the trading volume, I think its fairly well known that they will push the price up or down to point where they will finally enter, in order to get the price they are looking for, while at the same time clearing out all the traders stops, etc. This may not be entirely the case for some of the cross currency pairs, but it certainly is for example when looking at the most heavily traded pair, EURUSD. I think the banks advantage of being able to see the trading book so to speak (which retail traders don't have access to), stacks the cards against smaller traders. This is why I wonder if when currencies drop to a certain support level, is it really that they are oversold or are they just artificially reduced in price for the dynamics of the banks need for a better position for their clients and the banks trading portfolio.

Again, I am not trying to make a case for this, but more like trying to learn & gain perspective.

 

[AndrewS]

The only indicator I use is an exponential moving average. I watch the 20 period but any number will do if you become familiar with it. The EMA is helpful to me because it quickly shows how strong a trend is. The EMA is useless to me in a trading range other than to show the market constantly crossing it and confirming it is in a range. Other people find OB/OS indicators helpful in trading ranges but I do not and they often give bad signals in trends especially strong trends. A large part of the trading universe participates in the endless quest for the Holy Grail indicator. I gave up long ago and just watch the price action.

 

[Marcas]

SG. I like philosophical approach. This is a good way to understand what trading really is and gain broader perspective then when studying strategies can give. Unfortunately I do not trade nor think much about currencies, so no opinion from me about your take. I did mess with TA in the past though and my approach can be expressed in one word: whatever.
Good luck.