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Duration: 10:51

Instructor:

Contributor: MarketLife

Level: Beginner

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
Disclosure: MarketLife

These videos and accompanying educational materials (collectively, “the Educational Materials”) are created and authored by Adam Grimes (the “Content Creator”) and are published and provided for informational and entertainment purposes only. The information in the Educational Materials constitutes the Content Creator’s own opinions. None of the information contained in the Educational Materials constitutes a recommendation that any particular asset, instrument, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. You understand that the Content Creator is not advising, and will not advise you personally concerning the nature, potential, value or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the information contained in the Educational Materials may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Any statements about income, expressed or implied, does NOT represent a guarantee. Your actual trading may result in losses as no trading system is guaranteed. From time to time, the Content Creator or its affiliates may hold positions or other interests in assets mentioned the Educational Materials and may trade for their own account(s) based on the information presented. The Content Creator may also take positions inconsistent with the views expressed in the Educational Materials.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight.  In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or adhere to a particular trading program in spite of trading losses is material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

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Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Academy that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Academy 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 permission from MarketLife. The views expressed in this material are solely those of the author and/or MarketLife and IBKR 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 sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. 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.

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