The upper band represents overbought territory, while the lower band can show you when a security is oversold. Usually, once a lower band has been broken due to heavy selling, the price of the stock will revert back above the lower band and head toward the middle band. This is the exact scenario this strategy attempts to profit from.
The strategy calls for a close below the lower band, which is then used as an immediate signal to buy the stock the next day. This presented a clear signal that the stock was in oversold territory.
The next trading day was not until December 26, which is the time when traders would enter their positions. This turned out to be an excellent trade. December 26 marked the last time Intel would trade below the lower band. This is a textbook example of what the strategy is looking for.
While the price move was not major, this example serves to highlight the conditions that the strategy is looking to profit from. For related reading, see Profiting From The Squeeze. NYX was clearly in oversold territory. Following the strategy, technical traders would enter their buy orders for NYX on June This is the ideal scenario that the strategy is looking to capture. Opening a position on June 13 allowed traders to enter right before the turnaround.
In a different example, Yahoo broke the lower band on December 20, The strategy called for an immediate buy of the stock the next trading day.
Just like in the previous example, there was still selling pressure on the stock. While everyone else was selling, the strategy calls for a buy. That proved correct, as Yahoo soon turned around.
On December 26, Yahoo again tested the lower band, but did not close below it. This would be the last time that Yahoo tested the lower band as it marched upward toward the upper band. As we all know, every strategy has its drawbacks and this one is definitely no exception. In the following examples, we'll demonstrate the limitations of this strategy and what can happen when things do not work out as planned.
When the strategy is incorrect, the bands are still broken and you'll find that the price continues its decline as it rides the band downward. Unfortunately, the price does not rebound as quickly, which can result in significant losses. In the long run, the strategy is often correct, but most traders will not be able to withstand the declines that can occur before the correction.
The selling pressure was clearly in oversold territory. The strategy called for a buy on the stock the next trading day. Like the previous examples, the next trading day was a down day; this one was a bit unusual in that the selling pressure caused the stock to go down heavily. The selling continued well past the day the stock was purchased and the stock continued to close below the lower band for the next four trading days.
Finally, on March 5, the selling pressure was over and the stock turned around and headed back toward the middle band. Unfortunately, by this time the damage was done.
The strategy calls for buying Apple shares on December The next day, the stock made a move to the downside. This is case where the selling continued in the face of clear oversold territory.
During the selloff there was no way to know when it would end. There are times, however, when the strategy is correct, but the selling pressure continues.
During these conditions, there is no way of knowing when the selling pressure will end. Therefore, a protection needs to be in place once the decision to buy has been made.
The strategy correctly got us into that trade. Both Apple and IBM were different because they did not break the lower band and rebound. Instead, they succumbed to further selling pressure and rode the lower band down.
This can often be very costly. In the end, both Apple and IBM did turn around and this proved that the strategy is correct. The best strategy to protect us from a trade that will continue to ride the band lower is to use stop-loss orders. In researching these trades, it has become clear that a five-point stop would have gotten you out of the bad trades but would have still not gotten you out of the ones that worked.
In every scenario, the break of the lower band was in oversold territory. The timing of the trades seems to be the biggest issue. This selling pressure is usually corrected quickly. When this pressure is not corrected, the stocks continued to make new lows and continue into oversold territory.
To effectively use this strategy, a good exit strategy is in order. Stop-loss orders are the best way to protect you from a stock that will continue to ride the lower band down and make new lows. Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Tales From The Trenches: INTC Below is an example of how this strategy works under ideal conditions. Figure 1 Chart by StockCharts. Figure 2 Chart by StockCharts. Figure 3 Chart by StockCharts. Riding the Band Downward As we all know, every strategy has its drawbacks and this one is definitely no exception.
Figure 4 Chart by StockCharts. Figure 5 Chart by StockCharts. A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. Passive investing is an investment strategy that limits buying and selling actions.
Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life. If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...