Within The Volatility Band by Sylvain Vervoort
Take It From The Top, Or Bottom
In this fourth part of a seven-part series, we look at
catching reversals using the boundaries of volatility bands.
One of the indicator rules for my swing trading strategy
(IRSTS) is to catch potential reversal points using the
upper and lower boundaries of volatility bands. In
this article, I will show you how to create volatility
bands and use them to make buy & sell decisions.
There are many ways to measure price volatility; one of the
common ways is to use the average true range (ATR), originally
developed by J. Welles Wilder and introduced in his book New Concepts In Technical Trading Systems. The true
range indicator is the greatest of the following:
* The current high less the current low
* The absolute value of the current high less the
* The absolute value of the current low less the
Simply put, a stock experiencing a high level of volatility
will have a higher ATR, and a low volatility stock will have
a lower ATR.
Personally, I prefer to smooth results right from the first
data manipulation, which is why instead of using the closing price, I start with typical data, which is the high + low
+ close divided by three.
When the typical price of today is greater than or equal
to yesterday’s typical price, I will then use the typical
price of today minus the low price of yesterday. When
the typical price of today is less than yesterday’s typical
price, I will use the difference between the typical price
of yesterday minus the low price of today.
By default, I smooth this data by summing a 13-day
period. In Figure 1 you can see the difference between
a standard 13-period ATR graph in the middle and the
smoother ATR typical graph at the bottom. The rising
or falling volatility in a selected time period will usually
be smoother than the Wilder ATR. This better suits the
purpose behind the volatility band I want to create.