TRADING SYSTEMS
Targeting Price Areas
The Truth About Volatility
by Jim Berg
Many indicators can help identify volatility. But can you use
them to target specific price areas for entry signals, trailing stops,
and profit-taking opportunities?
Typically, volatility indicators are used to
determine the direction, strength, and momentum of a security. The average
true range (ATR), one of the more popular volatility indicators, measures
volatility by looking at the average price ranges over the past x number
of periods, taking gaps into account.
The true range indicator is the greatest of the following for each period:
-
The distance from today's high to today's low
-
The distance from yesterday's close to today's high
-
The distance from yesterday's close to today's low.
Most trading software packages include ATR in their list of
indicators, which you can usually overlay on top of a bar chart, as can
be seen in Figure 1.
FIGURE 1: POPULAR VOLATILITY INDICATOR. Here you see the
average true range (ATR) overlaid on a price chart.
ANALYZE IT
Typically, when analyzing ATR volatility, you would focus on volatility
at tops and bottoms and during price consolidation and retracements. However,
if you incorporate the ATR into a few simple formulas, you may be able
to identify where to enter and exit trades, and make a reasonable profit.
Before going any further, I think it's fair to say that I apply my ATR
volatility analysis only to securities that are in a rising trend. After
all, it is the path of least resistance. Who wouldn't want to buy securities
when they are rising and sell them when they are no longer in a rising
trend?
When is a security in a rising trend?
-
When it is making higher highs and higher lows on a weekly chart
-
When closing prices are above the 34-week moving average
-
When the 34-week moving average is rising.
The price movements in the weekly chart of The Boeing Co. (BA) in Figure
2 certainly meet these criteria. If you look at the chart, you'll see that
higher highs formed at (A), (B), (C), (D), and (E). Higher lows formed
at (F), (G), (H), (I), (J), and (K). Prices closed above the moving average,
which started rising in June 2003. The point at which the moving average
started rising would have been a good entry point for any long trade, but
it's possible to miss that trade. If you did miss the opportunity to enter
a trade at this point, where will you find subsequent entry signals?
FIGURE 2: A SECURITY IN A RISING TREND. Price movement meets
the criteria for a rising trend.
...Continued in the February issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the February 2005
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2005, Technical Analysis, Inc.
Return to February 2005 Contents
