The Balance of Power indicator is a unique indicator. It assesses the ability of buyers and sellers in driving the price of the stock to extreme levels. The Balance of Power indicator thus basically measures the market strength of buyers against sellers.
Understanding Balance of Power Indicator
The Balance of Power is calculated as [(Close price – Open price) / (High price – Low price)]. The value obtained is then smoothened using a moving average.
The Balance of Power indicator (BoP) is plotted above and below a zero line. However, it is not an oscillator, as it is independent of the price movements. Whenever the BoP is above the zero line, it indicates systematic buying. Whenever the BoP is below the zero line, it indicates systematic selling.
Uses of BOP Indicator
The Balance of Power indicator is used for mainly 3 purposes.
- For identifying the trend direction
- For identifying upcoming trend reversals or continuations
- For taking advantage of overbought and oversold conditions
#1 Identifying the trend direction
The direction of BoP indicator usually signals the trend.
- When BoP indicator is rising, the trend would be usually bullish.
- When BoP indicator is decreasing, the trend would be usually bearish.
#2 Identifying Trend reversals and Continuations
Whenever there is a (regular) divergence between the price and BoP indicator, it usually signals a potential reversal.
- When the price forms lower lows and the BoP forms higher lows, it is called as a bullish divergence.
- When the price forms higher highs and the BoP forms lower highs, it is called as a bearish divergence.
Whenever there is a hidden divergence between the price and BoP indicator, it usually signals a trend continuation
- When the price forms higher lows and the BoP forms lower lows, it is called as a hidden bullish divergence.
- When the price forms lower highs and the BoP forms higher highs, it is called as a hidden bearish divergence.
The figure below shows a hidden bullish divergence between BoP and price. Soon, the price surged upwards.
#3 Overbought and Oversold Conditions
When the BoP clusters its tops and bottoms, overbought or oversold conditions are said to be present. Successful traders keep an eye on these clustered tops or bottoms from the balance of power indicator for supporting their long or short positions.
How Traders Use BoP Indicator
There are various ways in which BOP indicator is used by traders for choosing their positions.
- When the BoP crosses above zero, it is considered as a potential buy signal. Traders go long.
- When the BoP crosses below zero, it is considered as a potential sell signal. Traders go short.
- When there is a bullish divergence, traders choose long positions.
- When there is a hidden bullish divergence, traders choose long positions.
- When there is a bearish divergence, traders choose short positions.
- When there is a hidden bearish divergence, traders choose short positions.
- The clustered tops or bottoms in BoP indicator are used to support the positions.
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