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Today we’re continuing our look at bigcharts.com’s “upper indicators,” or more precisely indicators that typically are derived from moving averages and often graphed along side the price chart. The chart above is one that has a stock price graphed along with its price channel. The price channel is a graph of the 20-day moving average of daily high prices and a 20-day moving average of daily low prices which creates a “channel” that prices typically move in. This is an investing tool very similar to Bollinger Bands but used in a very slightly different manner. Since this statistic tracks the average of high and low prices, a daily price which pushes past the bounds of the price channel is usually signal of the start of a trend as opposed to a warning that the price has become too much an outlier relative to its usual distribution.
The useage of the price channel is rather simple. Buy signals are made when the stock pushes past the upper channel line and the sell signal is made as the price pulls off the upper channel line and heads back to the lower channel line. If you still haven’t sold by the time the stock has hit the lower channel line, that would be a big flashing red warning light that it is indeed time to sell. On the chart above, I drew two trendlines. The left showing a decreasing trend which was signaled by an initial pulling off of the upper channel line then confirmed by the touching of lower channel line and a two month long fall which essentially rode the bottom channel line until June. The second trend line is an upward moving trendline. The trend seems to begin before the stock’s price surges past its upper trend line, but as a conservative investor it likely would have been smarter to wait for the confirmation of the surge past the upper trendline in mid-September.
Price Channel is an interesting statistic in that, clearly, it does not catch top and bottoms of trends but it does confirm trends and allow you to be confident in your buy and sell points. It is what might be classified as a “breakout” system in that it tells you when a stock has broken out of a current trend and is about to reverse its direction. It is, for the most part, only helpful at its extremes during uptrends and downtrends and completely useless as a tool when the stock is trading somewhere between its price channel.
As an interesting side note, I only realized today why the default values of Bollinger Bands and Price Channel and many other moving average statistics are based on 20-day periods. That is because we only trade during the weekdays (5 days a week) and a 20-day period would roughly correspond to tracking one month worth of price movements. I had always thought that 20-days was a rather small sample size, but taking this into account I am starting to realize that a 20-day/1-month based trend spotting strategy is likely sufficient for most short/moderate term investors (which I guess would be classified as traders) and, since I am the kind of person who typically likes to hold his positions for no more than 3 to 6 months, I think I may start to use more 20-day averages in my stock analysis. But, for those of you who are looking more long term, 50-day, 90-day and 200-day averages are likely a better option for long-term trend analysis. That being said, bigcharts.com does not allow for adjusting price channel and Bollinger Band analysis periods which is a little bit unfortunate. I will be looking for a better, free charting system and if anyone knows any please do let me know.
