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Strategies & Market Trends : Stochastics

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To: sammy levy who wrote (256)	2/26/1998 1:24:00 PM
From: Wayners	Read Replies (1) of 927

<<"You have to be able to predict what the future amount of volatility is going to be" Can u elaborate some more.>> Sure. Bollinger bands are also known as volatility bands. All they do is place envelopes around the closing price data such that a certain high percentage of the closing price data lies inside the envelopes. Prices that lie outside the bands are "unusual" price points because they don't fit in with the rest of the closing price data. This concept has to do with standard deviation. That's what it really is using. You've probably heard of "standard deviation from the mean". Well the moving average is your mean of the closing price data. Every closing price lies so many standard deviations away from the mean--the moving average. The idea is to place trades where the current price is too many deviations or in simple language--too far away from the mean--the moving average. The probability is for a price too far away from the mean to return to the mean. So if you short a stock that has gotten way above the mean--you then have a higher probability of the price dropping back to the mean and you make money. Pretty simple huh? When a stock is trading, it the price will spend periods of time where the price remains very close to the mean price. During these periods all of the price data is within the envelopes and the closer the data stays to the mean and stays there, the narrower the envelopes or bollinger bands become. These are periods of low volatility. At other times the price will spend periods of time where just about all of the price data lies far away from the mean or moving average. In order to get most of the price data inside the bands, the bands have to widen up. These are periods of high volatility. Prices don't fluctuate rapidly between periods of high and low volatility. The periods last several weeks or longer. By using bollinger bands you can SEE where the volatiltiy is increasing or decreasing simply by watching the distance between the upper and lower bands. If they are getting narrower, volatility is decreasing. If the bands are getting wider, volatility is increasing. The idea is to get a feel for knowing when volatility isn't going to get any lower or when volatility isn't going to get any higher. That's where I use an indicator I call bollinger bands on bollinger band width which I have posted on this thread. When you see that the bollinger band width is real narrow and is supported by its own lower band, the liklihood for an increase in volatility increases. You generally make the most money in the least amount of time when you enter a position just before the volatility increases dramatically. Stock prices change in spurts which increases the volatility and thus increases the bollinger band width. So you look for narrow bollinger bands right? Maybe. The only problem with narrow bollinge bands is, while you know what the future volatility is going to be---its VERY difficult to get the direction of the move right. That's the rub. Stochastics, chart patters, moving averages all help--but there's no guarantee. That's why people don't enter a position during the low volatility period. Instead they place buy stop or sell short stop order just above and below the point where the volatility increase is going to occur so that they get in somewhere in the beginning of the move. That way you don't have to get the direction right.

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