V.15:10 (429-437): On Using Volatility Bands by Ahmet Tezel, Ph.D., and Suzan Koknar-Tezel, M.S.

We’ve all seen a stock break out of its trading range and trend to new levels. The initial surge will appear as a sudden increase in activity, pushing the price higher. The higher prices often reach levels that indicate the stock is temporarily overbought and, after a pause, may continue to trend. Technicians use indicators to identify the temporary extremes, and one indicator is volatility bands. This article details two trading systems designed to take advantage of the breakouts.

Many software packages for technical analysis of the stock market contain volatility bands using standard deviations of prices (Bollinger bands, for example). The conventional application of Bollinger bands assumes that a stock is overboughtY´ as the price approaches the upper band, and that it is oversoldY´ as the price nears the lower band. By using overbought and oversold conditions, aggressive investors can countertrade frequently, expecting reversals of current short-term trends. Using volatility bands, we wanted to test a trend-following system trading outside the bands rather than a contrary system trading within.