  |
|
The Sleuth Hello again, Sleuths, In recent weeks, I’ve talked about utilities being an area of the market that appears weak, despite the current general overall strength. I came across the perceived weakness in utilities by reaching into my technical toolbox and pulling out some of my trusty implements. It’s been awhile since I’ve written about the tools of the trade I use to locate the best -- and worst -- places to invest in equities. So, let’s open the toolbox and see what might aid your efforts to search for profits in the market mines, shall we? If you have been watching the markets closely, you might have noticed some unusual recent trading patterns. The market has been up one day and down the next. Most of the broad-based indices have moved higher -- and are in up-trends. But those indices have taken a very unusual road to higher prices. ************************************* GOLD $2,000 The No. 1 rated advisory service editor in America is so sure gold will soar higher, he’s willing to GUARANTEE prices will land at least 257% above where they are right now... “And you don't have to pay him a dime for the details...” Find out five ways to get rich during the new gold rush in this special report... ************************************* Normally, when the stock market is in rally mode you see a series of strong up moves -- with one day following through on the next. Prices then pull back -- as volume contracts -- and we see the inevitable short-term “profit-taking.” The rally then resumes. That hasn’t been the case recently. What we’ve seen is more of a churning, uncertain environment. The majority of stocks have risen, but the averages are advancing in an uncertain, stutter-step fashion -- without the normal follow-through. So, while today’s equities climate lacks the clean, powerful moves we like to see, we sure have seen a lot of volatility. The market indices have moved in wide swings -- just not in a consistent direction. The back and filling in the averages has obscured the wild daily swings that have taken place. That got me to thinking about volatility and the tools you can use to study those trading swings. For if you can put the seemingly erratic day-to-day swings into some sort of larger context, wouldn’t you be better off? And what is the likelihood that the current trading patterns will continue for the next few days or weeks? Wouldn’t it be helpful if you could gauge the odds of a continuation of current price behavior -- or be able to anticipate a change in that behavior? Of course it would. Now, there are several different ways to measure volatility -- or the movement between high and low prices -- and divine its meaning within the larger context of overall price change. One way to look at volatility and price swings is to use one of the best-known technical indicators -- Bollinger Bands. Bollinger Bands are not a part of the trading system we use in MST Trader. But given that MST Trader is an options trading service -- with heightened importance placed on volatility and short-term price movements -- I often look at Bollinger Bands to attempt to gain an additional edge in the trading wars. But you don’t need to be an options trader -- or even a short-term stock trader -- for Bollinger Bands to improve your experience in the financial markets. Bollinger Bands can assist you if you have an intermediate-term investing time frame -- or even a long-term outlook. Today, I’ll tell you what Bollinger Bands are and how they are constructed. In my next Technical Tuesday column, I’ll mention a few ways that you can put Bollinger Bands to work to enhance your trading or investment analysis. As you might have gleaned from its name, Bollinger Bands were developed by the well-known market technician John Bollinger. Bollinger Bands are primarily used to evaluate the volatility of a stock or market index over a period of time. They are particularly useful when comparing the volatility of a stock or index to its relative price levels. ************************************* 13 of 14 Winning Picks Proves... You could see gains as big as 62% in 24 hours...or you pay nothing. If you have 10 minutes a day, you can start making explosive gains like 53.3%, 62.1% and 95.2%. Read this report to find out how... ************************************* Bollinger Bands consist of three lines -- two trading bands that surround, or envelope, a centerline. The centerline of the indicator is a moving average. Typically, a 20-day simple moving average is used to construct the indicator’s centerline. However, you can substitute other inputs, depending upon the time frame you are considering. For instance, Bollinger says the 20-day moving average is a good centerline to use for an intermediate time frame. However, if you are attempting to analyze a particularly short-term trend, you might find that a shorter period moving average would work better for you. In fact, Bollinger has said that a 10-day simple moving average often works well for shorter time periods. Conversely, Bollinger suggests that you might be better off using a longer moving average for your Bollinger Bands centerline -- such as a 50-day simple moving average -- if you are trading or investing in a long-term time frame. The major point to remember is that -- as with many other technical indicators -- the input you use should fit the time frame of your trading or investment program. So, although the 20-day simple moving average is the default input used for the Bollinger Bands centerline in most trading software packages and charting websites, you should experiment with different time periods and find the one that works best for you. How can you tell what works best? To answer that question, you need to explore the other facet of this useful indicator -- the trading bands. Prior to the creation of Bollinger Bands, some traders and investors used trading envelopes to place lines at a fixed percentage distance above and below a moving average. In developing the Bollinger Bands indicator, John Bollinger decided to substitute the concept of a standard deviation for the fixed percentage. For those of you who do not remember your high school mathematics, standard deviation is an arithmetic calculation. In the context of technical analysis, the standard deviation concept is used to estimate the percentage of a stock or index’s prices that fall within a certain range. For example, 68.3% of a stock or index’s prices would be expected to fall within trading bands that are located one standard deviation above and below the moving average centerline. The most commonly used input for the Bollinger Bands standard deviation calculation is two. That means that Bollinger Bands constructed with trading bands set two standard deviations above and below the centerline means would be expected to capture 95.2% of the stock or index prices you are scrutinizing. Just like the centerline, you could experiment with your standard deviation input -- e.g. 1.5 for a short-term time period and perhaps 2.5 for a longer time frame. The point behind using a standard deviation calculation to set trading bands -- rather than a fixed percentage -- is that the trading bands are dynamically related to both the recent price movement and the level of volatility of the stock or index you are examining. Since, by definition, the bands capture a certain percentage of prices inside of them, those bands must adjust to the current trading patterns by contacting or expanding according to those prices. That’s the beauty of Bollinger Bands -- they are adaptive, not static. The contraction and expansion of the bands serves two purposes. First, by constantly adjusting according to the most recent prices, the bands portray the up-to-date, likely expected trading range. Second, the width of those trading bands illustrates the current volatility level of the stock or index under study. It is often thought that when a stock or index trades up to its upper Bollinger Band, it has become overbought -- and ripe for a fall. And when that same stock or index falls down and touches -- or even penetrates -- its lower Bollinger Band, it is oversold and ready to bounce. Like most trading and investing concepts, things are not quite so cut-and-dried. That common conception is sometimes true. And sometimes it’s not. The proper uses of Bollinger Bands are a bit more complex than typically thought. Like most indicators, Bollinger Bands are most effective when used in conjunction with other market technical tools. In my next Technical Tuesday column, I’ll describe a few ways these interesting, adaptive bands can help you during these volatile times. Trade well, Mark Bail
Mark’s extended accuracy rates help him make good on this guarantee: Over the next two months, you will have the chance to pull in 4 1/2 times what Wall Street's "ace" stock traders make...or your money back. |
|
|
Mark Bail has spent several years studying the financial market as well as running several options, equities, and mutual fund newsletters... <click here for full bio> |
|
