The Trend

Three of the Most Powerful Technical Indicators

If you pull a rubber band too far, too tight, what happens?

It snaps back. 

The same thing happens with stocks.  If a stock, index, or ETF moves too high or too low, it typically snaps back, just like a rubber band. 

And we can spot the stretched rubber band by watching three specific technical indicators – Bollinger Bands, Williams % Range and Money Flow.

Bollinger Bands

When it comes to Bollinger Bands (plotted at standard deviation levels above and below moving averages, such as the 20-day moving average), stock prices tend to stay within the upper and lower bands.  While the bands themselves do not necessarily generate buy and sell trading signals, they can help traders understand where prices may be bottoming or topping out along the way.

In short, Bollinger Bands let us know how far we can pull our rubber band.  Here’s an example with Coca-Cola (KO).  Notice what happens when the lower or upper Band is hit or penetrated.

Typically, when the upper Band is hit or penetrated to the upside, we can begin to make an argument the rubber band has been stretched too far north.  When the lower Band is hit or penetrated, we can begin to make an argument that the stock could be about to pivot higher from an oversold point.

Sterling Trader® Pro Chart Courtesy of Lightspeed Trading

Williams % Range

Williams %R, also referred to as Williams % Range is a momentum indicator that measures overbought and oversold conditions.  What’s interesting about Williams is its uncanny ability to signal reversals two days before reality strikes.  Traders can use the indicator to confirm Bollinger Bands. 

Generally, if the indicator climbs to zero or above, an asset is considered overbought.  If the indicator slips to or below -100, an asset is considered oversold. 

Let’s revisit Coke again.

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When Williams reaches near zero, it’s overbought. When it reaches to -100, it’s oversold.   

Look at what happens when the KO stock hits the upper Bollinger Band, as Williams reaches toward zero, the stock reverses about 80% of the time.  Now look at what happens to KO when the lower Bollinger Band is hit, and Williams % Range dips to -100. 

Again, the stock reverses about 80% of the time.

Money Flow (MFI)

Money Flow is another indicator that can be used to confirm potential overbought and oversold conditions, when used with Bollinger Bands and Williams % Range.  This is another momentum indicator that measures the inflow and outflow of money into a trade.  When MFI hits or penetrates the 80-line, the asset is considered overbought.  When it hits or penetrates the 20-line, the asset is considered oversold.  It can simply be used to confirm findings with Bollinger Bands and Williams % Range, telling us when an asset is likely to pivot in the other direction.

Sterling Trader® Pro Chart Courtesy of Lightspeed Trading

When you plot Bollinger Bands, along with the Williams % Range and Money Flow Index indicators, it can give you a better picture of when market reversals are likely to happen.

This article is provided for educational purposes only and is not considered to be a recommendation or endorsement of any trading strategy. The author is not affiliated with Lightspeed Trading and the content and perspective is solely attributed to the author.

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