AOTB Mini Series
Hello Bubble Riders!
I don’t like technical analysis as you normally find it. My primary reasons are two-fold: they’re hard to test, and they’re not typically responsive to broader environmental changes–unusually fast interest rate hikes or COVID, for example.
That said, they often serve as self-fulfilling prophecies, because so many people act on charts. They’re probably not worth completely ignoring, as a result.
Still, how do you fix for the problems mentioned?
We’re introducing “smart charts” = charts boosted by algorithms. We’ve already included a couple in our latest State of the Market report for DIY-ERs, we’ve Tweeted a few of these out for free already.
I see these as a sort of complement to our three-stage algorithm–which is a much longer-term strategy, aiming at about once a month trades. These charts, by contrast, aim at short 1 to 5 day trades, which win more often than they lose and win by wider margins too.
This will be a useful exercise for everyone, even if you’re not a paying subscriber. So, let’s get to it.
Using Bollinger Bands The “Wrong Way”
Bollinger Bands are typically bands that represent the two standard deviations of price movement away from a central price line–where the sample set is conducted over 20 days. For example, here’s TSLA’s BB (with a typical 2, 20 set up).
The orange line is the price envelope indicating 2 standard deviations of price movement. What that means is that a close above the top or bottom side of the orange envelope is statistically unusual–it represents a price in the top (or bottom) 5% of prices over the past 20 days.
If you read articles explaining Bollinger Bands on Investopedia, they’ll tell you that Bollinger Bands are supposed to be mean-reverting indicators. When the price breaks out above or below one of those bands, you’re supposed to count on a mean reversion in price movement (going back to the middle).
The problem with that advice is that it typically produces terrible returns. Just have a look at this streak again.
It broke upwards and just kept going (and the same happened to the down side just a little later). This sort of the result tends to be the rule rather than the exception with volatile stocks.
The only time this advice seems to work is when you have an extremely slow moving (low beta) stock and a calm macro environment. No cryptos have that quality, btw.
So, we decided to turn the conventional wisdom on its head. What if breakouts were a sign that more was to follow? What if we adjusted the parameters a little bit to make that signal more reasonable?
And that’s what we did.
Our BB signal is a trend following signal. It tells you when to enter a trade, namely at a breakout above or below the envelope.
But when do you exit? What’s your target gain? What should you set your stop-loss at? These questions are answered with charts.
Fibonacci Retracement + Resistance Analysis
Given our entry signal, we overlay standard resistance analysis and the Fibonacci sequence to identify target gain and stop-loss prices.
Here’s an example of what you get.
Enter from the BB trend line. Exit and Stop Loss placed at the Fibonacci intervals.
If your trade is still uncertain, double check with resistance lines. You should notice that the exit point overlaps with some standard resistance lines from the previous low.
But theory is one thing. How’s it work in practice?
Example: Our ETH Trade
Well, the team Tweeted about our recent ETH trade using this system on Oct 25.
It looks about right. This is picking up on the anticipation of a Fed slow-down in the pace of rate hikes (from 75bps in Nov to 50bps in Dec). It’s the rally I’ve been writing about.
So far, the trade hit exactly the Fibonacci line ($1666) and retraced. Here’s an updated version of that chart.
That was entry at: $1342. Target Exit at $1666. Total gain 24%. Number of days held 4.
Could it go up higher? Of course, and that target would be a psychologically strong $1800 mark. I’m happy with 24% in 4 days in this environment.
This use of smart charts makes technical analysis more reliable and we’re including it in our DIY-ER subscription package (to be re-named Data Rider).
The specific strategy outline here is useful for high-volatility asset classes only, because it uses Bollinger Bands the “wrong way,” to trend follow, rather than mean-revert.
At present, we’re placing some charts that we find interesting at the end of our State of the Market report. I think we’ll do more of that given feedback from the community. That way, you’ll get a perspective for weekly picks, given the macro-picture and given what the charts say.
Crypto Riders and Bubble Riders will continue to get full algorithmic access (of course).
This week I wrote a number of pieces that are related to this post, so you might want to have a look if you’ve missed them.
That’s it for this week. Remember to join us on Discord if you haven’t already.
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