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
Disclosure: Interactive Brokers
Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from MarketLife and is being posted with its permission. The views expressed in this material are solely those of the author and/or MarketLife and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
