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Edited for emphasis:
>>> Bollinger Bands:
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A cardinal rule for the successful use of technical analysis requires avoiding multicolinearity amid indicators. Multicolinearity is simply the multiple counting of the same information. The use of four different indicators all derived from the same series of closing prices to confirm each other is a perfect example.
So one indicator derived from closing prices, another from volume and the last from price range would provide a useful group of indicators. But combining RSI, moving average convergence/divergence (MACD) and rate of change (assuming all were derived from closing prices and used similar time spans) would not.
Here are, however, three indicators to use with bands to generate buys and sells without running into problems. Amid indicators derived from price alone, RSI is a good choice. Closing prices and volume combine to produce on-balance volume, another good choice. Finally, price range and volume combine to produce money flow, again a good choice. None is too highly colinear and thus together combine for a good grouping of technical tools. Many others could have been chosen as well: MACD could be substituted for RSI, for example.
The Commodity Channel Index (CCI) was an early choice to use with the bands, but as it turned out, it was a poor one, as it tends to be colinear with the bands themselves in certain time frames. The bottom line is to compare price action within the bands to the action of an indicator you know well. For confirmation of signals, you can then compare the action of another indicator, as long as it is not colinear with the first.
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Trading bands answer the question whether prices are high or low on a relative basis. The matter actually centers on the phrase "a relative basis." Trading bands do not give absolute buy and sell signals simply by having been touched; rather, they provide a framework within which price may be related to indicators.
Some older work stated that deviation from a trend as measured by standard deviation from a moving average was used to determine extreme overbought and oversold states. But I recommend the use of trading bands as the generation of buy, sell and continuation signals through the comparison of an additional indicator to the action of price within the bands.
If price tags the upper band and indicator action confirms it, no sell signal is generated. On the other hand, if price tags the upper band and indicator action does not confirm (that is, it diverges). we have a SELL signal. The first situation is not a sell signal; instead, it is a continuation signal if a buy signal was in effect.
It is also possible to generate signals from price action within the bands alone. A top (chart formation) formed OUTSIDE the bands followed by a second top inside the bands constitutes a SELL signal. There is no requirement for the second top's position relative to the first top, only relative to the bands. This often helps in spotting tops where the second push goes to a nominal new high. Of course, the CONVERSE is true for LOWS.<<< |
