SOME INSIGHTS INTO THE WORKINGS OF BOLLINGER BANDS, MOVING AVERAGES, AND CANDLESTICKS AS PERTINENT TO SHORT-TERM STOCK TRADING
<re: bollinger bands and candlesticks...any gut feeling on the relative similarities/differences?>
ynot,
Well, at Eric P.'s urging, I had sworn off writing too many of these this weekend, but the question comes from my old friend ynot...
Bollinger Bands are nothing more than a shifted (displaced up, and down) pair of moving averages which "contain" price. Bollinger's are a somewhat exotic type of trading band, there are simpler forms. What is unique about Bollinger's, is that their distance away from price VARIES with volatility, according to Mr. Bollinger's nifty formula (which has probably made him milions, in name recognition). A more "basic" type of band worth studying is the KELTNER band, they are less exotic (i.e., simpler) and therefore, IMHO potential more useful to a pragmatically-oriented stock trader (less cluttering, while still presenting the useful information).
The Bollinger band adds the concept that the distance of the band away from price, is a function of volatility. This is cute, fancy-dancy, etc. but not necessary at all - unless you're an Albert Einstein level trader like John Bollinger probably is, who needs the complexity? So I recommend sticking with the simpler Keltner Bands.
Anyway [end of soapbox] Trading Bands are truly great when used properly - the neatest thing about trading with Bands is: they are useful in either a sideways (non-trending) market (like now), where you can sell the upper band, and buy the lower band - trading either long or short. If you set them up properly for what you're trading, those bands can represent your statistically-likely "boundaries" for price. The principle of trading with bands as indicators is, BANDS CONTAIN PRICE. This is strictly a probability thing. Jake Bernstein has published some excellent, pragmatic Band-trading techniques that work, among others.
Let's diverge into the underlying topic of Moving Averages themselves, for a single (albeit long) paragraph. Moving averages are a simple mathematical concept. Some traders understand exactly how they work, others use them but don't understand them yet (nothing to be ashamed of, it takes a while!). If you're not using them yet, you're missing a lot - the rules of "relativity" (that is, price relative to the various MA's). These are UNIVERSAL rules, get it? It helps to understand how MA's really work, because then you can use them more intelligently. The concept is, you're taking a running sum of closing prices on the bars, on a moving-window basis (lagging the latest price), then dividing by the number of bars being averaged an average on "n" data points, which moves with prices as the bars advance... so what you have is the "running average" of the closing price of the last "n" bars. "Simple" moving averages (SMA's) are a straight average - for example, add up the last 10 closing prices, divide by ten. "Exponential moving averages" (EMA's) weight the newest bars more heavily, thus are "faster" (more closely tied to the latest price bar). Like Bollinger Bands, I recommend dispensing with the complexity of EMA's, and KEEP IT SIMPLE. The real-world improvement from EMA's is fractional, and it is slower for you PC to compute (on each MA, on each chart you have open - I run 4 screens per PC, with nine charts per open sub-page, ten worksheets per screen to toggle between... it can add up and will slow your SW down). Today, many traders (including the institutions managing big positions) carefully watch the MA's, and that is partially what makes the moving averages so powerful - traders react to them. I throw this in, because Bands are simply a hybrid, composite application of moving averages - an indicator "synthesized" from MA's. The proper application of MA's in trading has filled many, many books. The most intriguing thing about them nowadays is, with so many traders watching the market using them, to not know where they are located, is like flying blind. I watch the 10-period, the 20, the 40, 50, and 200. This applies in all time frames - 1-min chart, 5, 15, 30, 60, daily, weekly, etc. MA's provide a RELATIVE reference for prices, which is universal. I touched on this concept in an earlier post, it can be very rewarding to fully understand. For more pragmatic info Linda Raschke has some good work on this she has published (prob. available on her website), and Greg at Pristine Capital has done some important analytical work in this area, tailored for stock trading applications, which is quite insightful and can be very useful.
Bands work very well in trending markets. In an uptrending market, for example, you would look to buy prices near the lower band, and sell near the upper band. They sort of serve a dual role, as a moving average indicator, and as a stop-loss guardian. Some traders will place their stops say, one or two ATR's (average true ranges) outside the band, for swing-trades.
Unfortunately, in today's market, securities rarely trends so nicely/neatly as to fit into a simple "band" model. But it does happen, at times. For example, a lot of the tech sector coming out of last fall's correction.
Now for Candlesticks. Candlestick charts have been used in Asia for centuries (first to plot the price charts for Rice) - they are a generic tool. They work just as well today, for stock traders looking at 1min, 30min, or daily charts. I don't really see Candlesticks as an "indicator", although I suppose you could look at them that way. It is just a clever way to display a price bar, to make the information contained therein much easier to grasp whether scanning, or looking at closely, bar-by-bar. Generally, the only problem with candlesticks is GETTING USED TO THEM. Take the plunge, they are definitely worth it - I use to love "bar" charts, but can't even stand to look at them now. Although it might prove useful, it is not necessary to learn all of the nicknames (Doji, etc) for Candlesticks in order to make complete use of them. The big advantage comes from the fact that the "body" stands out clearly, and the high/low in relation to that...illustrating the price action more clearly, and aggregating it better (the human eye integrates the information better). You must develop a good understanding of how to interpret that price action, in order to make the best use of candlesticks. That is another topic - I took an excellent 3-day 1-on-1 S&P futures-trading course from Rick Mitchell up in Detroit a few years ago, which was a real breakthrough for me in that area.
To further explore this, start regularly studying a single (OHLC or Candlestick) bar on a daily chart, and ask yourself what that means in relation to what happens tomorrow. You'll start seeing a lot of patterns. Then study two bars, relative to one another. Then three, etc. Once you get a handle on it, this sort of thing is more powerful than technical analysis, for short-term trading - it's really "pattern analysis". It works on patterns in all time frames, some better than others. That's why the top traders must have pattern (price-action) confirmation as their final filtering criteria, for entering a trade. For example, look at the material in any book by Jeff Cooper, Linda Raschke, Larry Williams, Jake Bernstein, Larry Conners, etc. Same thing - and, this is what Candlesticks are all about - bringing clarity to the analysis of price action itself. Moving averages are DERIVED from price action, there is averaging; smoothing involved. Candlesticks ARE the price action!
Regarding your comment about the similarities/differences, I see Candlesticks as an orthogonal concept to bands. Candlesticks provide you with a much more vivid, clear way to analyze the price action from the bars in charts (compared to OHLC "bar" charts). It's like seeing in color, instead of black and white. I use technical analysis as the course filter, then price action (Candlestick bar) analysis as the fine-grained, "trigger" for my entering a position. Candlesticks facilitate this. The best books are by Nissan, I can post the two books he's written later, or maybe someone else on the thread remembers them.
Good trading, -Steve |
