the hAndbook of technIcAl AnAlysIs■ (^) Amount of divergence between the bands
■ (^) Distance of price from the bands
■ (^) Bandwidth as a function of price and volatility
We shall now focus on the function and construction of various bands and
envelopes.
Function of an envelope or band
Envelopes or bands have six main functions, namely:
- As a means of gauging the average volatility of price action
- As an indicator of overbought and oversold conditions
- As a means of identifying potential levels of support and resistance
- As a price trigger for initiating entries or exits
- As a means of trend identification
- As a way to trade moving averages without excessive whipsawing during
consolidations
The direction of the central value and bands indicates the general direction of
the trend since it contains the trend within it most of the time. The majority of the
central values are in fact moving averages, which are smoothed versions of any
existing trend. See Figure 12.1 bands and central value indicating trends in the
S&P GSCI Energy Index.
The upper band, lower band, and the central value all represent barriers to
price action. As barriers to price, the bands provide support and resistance. But
here is the important difference between bands and other barriers of price action.
For example, it should be noted that in a downtrend, the lower band tends to be
more reliable as support than as resistance while in an uptrend, the upper band
Figure 12.1 Bands and Central Value Indicating Trend Action on the S&P GSCI
Energy Index.
Courtesy of Stockcharts.com