Bands, Envelopes and channels -

Below is an article about the basic principles on bands and envelopes for use in your trading decisions.
I think it would be fair to say that most of you will have heard of at least one form of "band" indicator - that being Bollinger Bands.
These are named after their creator - John Bollinger - and seem to have wide acclaim. (i am still learning remember, so cannot say how i feel yet, experience will tell)
But, if you want to know more about Bollinger, then i do highly recommend you go direct to the source, to John Bollingers website.
But before you rush off, here i have put a quick link to some of his free principles on band indicators that should save you some time hunting his site.
This free info is great, but detailed and long i feel. So, if a brief overview on the principles is good enough, then read on.....

How do we monitor a trend to watch for any changes in the overall strength of stocks?
Envelopes and bands offer one quick way of keeping your eye on the bouncing markets.
This form of analysis shows that if we use the Canadian TSE 300 Composite Index as an example, the index is still in a healthy uptrend. However there was a sign of potential weakness during late July - early August (see chart below for example).
What does the chart look like today? The MA envelope plots two lines placed at a fixed percentage (e.g., 3%) above and below a Moving Average (thus also known as Percentage Envelopes). A strong penetration through the envelope in either direction can be a useful indicator. Usually a filter mechanism is added to ensure that the penetration is truly significant; the most commonly used filter is a certain number of closing prices outside the envelope - usually 3 consecutive daily closes.
You can see how the MA Envelope is not very helpful during sideways trending markets - shown by the blue trendlines.
Once the market began to trend in early June, however, the signals offered by the MA envelope system once again proved very helpful.

In the TSE chart below we can see that as long as the price stays above the centre moving average and along the upper envelope, we can be fairly safe in assuming that the trend is healthy and set to continue. The current price is right on top of the upper band; sign of a continuing healthy uptrend at this time.
Remember, as with any indicator, the signals are not 100% reliable (they never are!). This is why you need to confirm any signals using other indicators.


The next chart shows the TSE 300 again, this time using the Price Channel indicator (focussing on the past 3 months). Also known as the 4 week rule or the Dochian Channel (after its original developer Richard Donchian); this indicator is simple but it works extremely well. Basically it tells you what the price is doing in relationship to the highs and lows of the previous 4 weeks. The upper line (or channel) plots the highs of the previous 4 weeks (20 trading days), and the lower line plots the lows. A breakout above the upper line shows that the market is exceeding any highs set over the previous 4 weeks. Once again, a strong penetration though the upper channel with at least 3 consecutive closes above the line can be considered a good buy signal.


Price Channels and MA Envelopes should be used in combination with other indicators, such as RSI or MACD, to provide confirmation of the strength of a market. An exit strategy utilizing trendlines and other indicators can be particularly important. Waiting for the price to close below the lower band often erodes much of the potential profits from a good move.
Compare the two sets of charts to see what these two systems are telling you. I would also recommend using these techniques to monitor the health of some of the other indices as well as sectors.

TIPS & TECHNIQUES - Using Bands & Channels
The Price Channel is a simple breakout system. As a trend following system the Price Channel indicator is not meant to catch tops or bottoms. Trend traders may want to extend the period to eight weeks to wait for significant trend signals.
Similarly, some traders shorten the time period to a more sensitive 1 or 2 weeks for liquidation purposes. See Price Channel

Bollinger Bands are two winding parallel lines above and below a central moving average (MA) create a band that contains the majority of price movements within a channel. This is similar to moving average envelopes. The difference is that Bollinger Bands are also sensitive to volatility in the market. The bands spread further apart during volatile markets and come closer together during calmer markets.

See Bollinger Bands

The Keltner Channel is based on the Average True Range and is sensitive to volatility. It may be used in place of standard deviation (Bollinger) bands or percentage envelopes.See Keltner Channel

PROFIT POTENTIAL - Fairfax Financial
Fairfax Financial (FFH) on the Canadian TSE has been in a strong downtrend and sideways trend since December 1999. It is showing signs of a possible bottom. When we apply trendlines and Bollinger Bands to this stock we can see that it may be showing signs of a turn around.


Here's FFH over the past six months with Bollinger Bands shown. The red circle shows an enlarged view of the price action when the price penetrated through the upper band and made three consecutive closes above the line. This is usually considered a buy signal with Bollinger Bands.


You might want to experiment with the use of MA Envelopes and Price Channels on this same stock to see if they provided added evidence of a possible turn-around for FFH.