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
- Offset by a standard deviation (of price)
- Offset by a multiple of Average True Range (ATR)
(20 per SMA, +/- 2 ATRs)
(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.
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?
- 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
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
- Mean reversion
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