ENVELOPES AND BANDS
Many
traders think of the market as being either in a state
of equilibrium or disequilibrium. A market that trades
within a narrow range similar to the congestion patterns
discussed earlier might be considered a market in a
state of equilibrium. From a fundamental perspective the
supply and demand forces are balanced.
A
market breaking out of a range, or envelope, and
developing a trend would be one in a state of
disequilibrium, or out of balance. A market out of
balance searches for a new equilibrium level by probing
new highs or lows. From a fundamental perspective, the
supply and demand forces are not balanced, so the market
is driven up by demand or down by supply.
Bands
or envelopes may be placed above and below the highs and
lows in the market to delineate the equilibrium levels.
Any significant penetration above or below the bands
would be construed as a break of the equilibrium level,
which would generate a buy or sell signal.
There
are many ways to construct these bands. One way to
create the bands is by using a moving average of the
highs and lows. A buy signal would be generated when the
market penetrates the high band. A sell signal would
occur when the market penetrates the low band.
In
general, the tighter the band the more frequent the
signals and possible whipsaws. The wider the band the
less frequent the signals, but a greater part of the
move is missed. Many of the trade-offs mentioned in the
moving average section, such as shorter and longer time
frames, would apply equally well with envelopes.
These
methods are normally used as a trend following system,
hut they may also be used in countertrend trading. In
this case a break above the band would be construed as a
sell signal, and a break below the band would be a buy
signal.
Oscillators cover a
broad class of indicators which measure movement
about an equilibrium level, usually designated as
zero. An oscillator is often used to identify
overbought and oversold conditions. Another use for
oscillators is to establish confirmations and non-confirmations of market movements. Some use
oscillators in trend following methods similar to
moving average systems.
When oscillators are
employed in counter trend trading, many of the
trading rules may yield signals opposite to those
developed for moving averages or trend following
methods. Since oscillators and moving averages can
be mathematically similar, the trader is free to use
either study in any way deemed appropriate. There
are certainly plenty of traders who wish they had
employed the "standard methods" the opposite way,
after losing money the old fashioned way.
Envelopes, Bands and
Oscillators Trading System
