It is often said that the candlestick models of the reversal should be applied only when the market is at the high/low price level. The Disparity Index indicator is used to define these levels. I.e. when the histogram bars are blue and rising above the overbought level, you must search the candlestick combinations that signal about down reversal. And, vice versa, if the histogram bars fall below the oversold level and changes the color to red then look if it coincides with some candlestick model of up reversal.
Although you can use a fixed overbought/oversold level (3-10 percents depending on the market and the indicator parameters), this version levels are calculated dynamically. Behavior is the following:
- calculates the absolute value of price change in percentage in each bar
- calculates the average value of these changes for the set period and multiplies it on the coefficient. The received value is the overbought level. The same value with a minus sign is the oversold level
- when overbought/oversold levels are overcome then it is recommended to use in combination with the candlestick models.
- when the difference index is between overbought/oversold levels, it can serve to define the trend. The increasing index indicates of the bull market, the decreasing index is about the bear market.
- another way of application is divergence trade.