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A few weeks ago we discussed moving averages as a means to determining trend and support levels within a trend. In essence due to their lagging characteristic, in an uptrend prices tend to find support from a moving average and remain above it, while in a downtrend the moving average provides resistance and price action remains below

the average.

One refinement of moving averages is to apply trading bands. These are lines which are drawn above and below the moving average. The method by which these lines are drawn varies according to method. One method of drawing these bands is to add and subtract a set percentage of the moving average value to that average. Perhaps two percentage bands might be selected to try to contain the majority of price activity. Another method made popular by John Bollinger, is to apply a set number of standard deviations. The advantage of this latter method is that the width of the bands varies according to the volatility of price action and this can add additional value to this technique.

The bands widen during periods of high volatility and close in and pinch price action when low volatility is present when often such a condition precedes a significant move, as happened on our example chart last October. Statistically applying bands based on two standard deviations should encompass 95% of price action and this is the most usual setting adopted for this method. Typically, over the life of a trend, price action is expected to deviate from its moving average to some extent but to revert toward the moving average as and when that deviation gets too large. Therefore during an uptrend prices might be expected to trade between resistance from the upper band level and support from the moving average and vice versa during downtrends, the two lines providing useful stop levels for short-term trades. If the price moves and close through the band line then this can signal an accelerating trend. More likely is that price action hits the band line and during the trend continues to pressure the line every few days. However, as the trend weakness, price action reverses back toward the moving average. The average may support and the trend re-establish, but band trading theory suggests that you should expect prices to move through the average line and at least make a test of the opposite band line.