Bands and Channels: Monitoring Extension and Momentum

Duration 10:51

Level Beginner

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Bands and channels are one way to precisely define and to measure the distance that the market has moved from a moving average. In this lesson we’re going to look at some of the different types of bands, options for setting them up, specific ways to use them to quantify overbought/oversold conditions in markets, and then we’re also going to talk about what bands can tell us about momentum. We’ll cover Bollinger Bands, Keltner channels, and Moving Average Channels.

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Study Notes:

Why Use Bands or Channels?

Markets In Relation to Moving Averages

How Far is “Far Away”?

20 SMA w/ 2.25 ATR Keltner Channels

Why Bands or Channels?

Markets behave differently in equilibrium compared to when momentum is driving them.

Looking at how close or how far a market is to a moving average is one way to measure momentum.

Bands are a structured way to measure distance from a moving average.

Types of Bands

Moving Average Channels

Offset from a central moving average by a percent of price

Bollinger Bands

Offset by a standard deviation (of price)

Keltner Channels

Offset by a multiple of Average True Range (ATR)

Keltner Channels

(20 per SMA, +/- 2 ATRs)

Bollinger Bands

(20 per SMA, +/- 2 Std Devs)

Overbought / Oversold

This is an important concept in technical analysis…

But it’s also a thorny concept!

An overbought market:

Is potentially over-extended to the upside (“too strong”)
And maybe due for a selloff

Oversold is the reverse.

Be Careful

Do not assume that something will or must happen.

At best, any tool only gives us a tilt in probabilities.

This is the definition of a trading edge.

Overbought/oversold markets can carry high risk:
These points come in strong trends

They can also come with extreme volatility

Overbought markets can get more overbought and stay overbought longer than anyone might expect!

At What Point Was the DJIA Overbought?

Momentum

Several definitions:

The difference between two closes (standard TA indicator)
Acceleration of the change of prices (slope of an MA)
The tendency for strong assets (relative to other assets) to become stronger

The tendency of prices to continue to move in one direction

Offsetting force is mean reversion

Using Bands to Measure Momentum

Summary

Bands or channels are one way to measure distance from a moving average.

Different ways to structure and use bands or channels

Three important concepts:

Overbought / oversold
Momentum
Mean reversion

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