HUI Bollinger Bands
Adam Hamilton
Archives
December 19, 2003
Last week in "Standard-Deviation
Technicals" I discussed the logical and philosophical
foundations behind the idea of applying the statistical concepts
of normal distributions and standard deviations to technical
analysis of financial prices.
While it all sounds complicated,
the underlying ideas are actually anything but. Markets tend
to abhor extremes, and markets always tend to revert back to
their means over time certainly very easy to understand! The
more statistically extreme that prices become, the higher the
odds that they will soon mean revert.
As speculators, when we find
ourselves observing current conditions where prices are running
two or three standard deviations above or below their key moving
averages, we can be almost certain that the probability is increasing
that these very prices are due to reverse over the short-term
and swing back in the opposite direction.
Since speculation is ultimately
little more than putting our scarce and valuable capital on the
firing line when probabilities seem to be in our favor, standard-deviation
analysis provides a valuable tool for analyzing these ethereal
odds. Standard deviations grant us another crucial perspective
on whether a particular price happens to be relatively high or
relatively low at any given moment in time.
In last week's foundational
essay, we used standard deviations built off of really long-term
200-day moving averages to build our charts. This week I would
like to expand on our standard-deviation technical analysis,
migrating in two important directions.
First, we will limit our focus
to the fascinating HUI unhedged gold-stock index, ground zero
for the accelerating bull market in gold and gold stocks. Fortunes
have already been won in this gold-stock bull for the daring
early contrarians who were stalking this thing way back when
it began. From a long-term perspective though, the really staggering
Great Bull gains are never earned until the final bubble years,
so the best almost certainly still lies ahead.
Second, as we are moving from
the realm of standard-deviation theoretical into practical, our
HUI standard-deviation-band charts this week use John Bollinger's
own SD-band conventions. There are a couple key benefits to using
what are considered classic Bollinger Bands while analyzing the
HUI.
Conventions become conventions
because they have been observed to work rather effectively in
the past. Rather than starting with an unconventional approach
and moving back towards conventional, it makes much more sense
to begin with the accepted and expected and tweak our analysis
from there if necessary. In addition, most charting software
easily renders standard Bollinger Bands so following convention
will make it much easier for folks to replicate these charts
on their own computers if they wish.
Bollinger Bands, while not
explicitly defined, through standard usage have come to generally
mean price bands drawn two standard deviations above and below
a 20-day moving average. To compute them you just create a 20dma
of a data series, calculate a rolling 20-day standard deviation
of the raw price data itself (not an SD of its 20dma!), and add
and subtract two times this SD number from the original 20dma
line. The resulting graph shows raw prices within an expanding
and contracting SD pipeline centered on their 20dma.
These 20dma-based +/-2 SD Bollinger
Bands are recommended for intermediate-term trading, or positions
designed to be held for weeks to months. By statistical definition,
95.4% of prices ought to lie between these two lines, so a price
outside these +/-2 SD bands should only happen in about 1 in
22 trading days on average.
Longer-term SD-band analysis
uses 50-day SD bands of raw price data graphed above and below
a price's 50dma. Technical analysts generally use +/-2.5 SD bands
for longer-term trading, for positions expected to be held for
months to over a year. Statistically, market prices ought to
be within two and a half standard deviations about 99% of the
time on average.
Outlying price data should
only happen about once in every 100 trading days on average,
but as I discussed last week market-price bell curves have fattened
tails and are not true normal distributions. Thus extreme outliers
happen more often than statistics predict. Nevertheless though,
even with fat-tailed bell curves standard-deviation analysis
is a very valuable addition to any technical-analysis toolbox.
In this essay, we are actually
looking at both sets of SD bands for the HUI, the standard 20-day
+/-2 SD Bollinger Bands as well as the longer-term 50-day +/-2.5
SD Bollinger Bands. We will start with the longer-term 50-day
bands and then zoom into the present from a short-term 20-day
SD perspective.
It is really amazing to behold
just how many major short-term turning points within the long-term
secular gold-stock bull uptrend were carved exactly on key standard-deviation
lines! The HUI conforms rather nicely to the conventional standard-deviation
parameters of classical Bollinger Band analysis.
While the red Bollinger Bands
in this chart use rolling standard deviations of 50 days of raw
HUI price data, the blue line, these +/-2.5 SD bands are keyed
off of the 50dma itself, the white line. Thus these Bollinger
Bands form an expanding pipe around the 50dma when volatility
is rising and a contracting pipe centered on the 50dma when volatility
is waning. The oscillation of actual HUI index levels within
these long-term Bollinger Bands is quite fascinating.
These HUI Bollinger Bands enable
us to quickly process a huge pile of complex statistical data
visually without even taxing our brains! Statistically the HUI
ought to be meandering between these two two-and-a-half-standard-deviation
bands about 99% of the time, so when it manages to sprint outside
this SD-band pipe we immediately know that a fairly rare and
noteworthy event is transpiring. Speculators can immediately
see whether the HUI is relatively high or relatively low at any
given moment by checking its position within its Bollinger Band
trend pipe.
As this chart clearly reveals,
major short-term turning points for the HUI generally coincided
with the kissing or piercing of one of its own Bollinger Bands.
The red arrows highlight some of the most important short-term
trend changes within the gold-stock bull to date, key moments
in time when speculators who made the right decisions were richly
rewarded by the markets.
While Bollinger Bands alone
are not designed to trigger primary trading signals, the relative
position of the HUI within its Bollinger Bands helps speculators
game the probability of a short-term turn in the key gold-stock
index. The farther that the HUI manages to migrate away from
its 50dma in standard-deviation terms, the higher the probability
that this particular extreme anomaly will not last long. All
of the major turning points above were marked by moments where
SD-band probabilities were extremely favorable for a tradable
short-term trend change.
Interestingly however, there
seems to be great asymmetry in the relative value to speculators
of knowing that the HUI happens to be approaching its lower Bollinger
Band as compared to its upper one. While the HUI has hugged its
upper Bollinger Band for months at a time when it is really running
hard, obscuring a specific SD sell signal, whenever it managed
to bounce off of its bottom SD band a fantastic buying opportunity
existed.
As the lower red arrows in
the chart above show, the greatest rallies within our entire
gold-stock bull to date have all launched from -2.5 SD or so
levels on the HUI. When gold stocks become so beaten down on
short-term pessimism and fear that they trade two-and-a-half
standard deviations or more under their 50-day moving average,
odds are that this anomalously dark situation won't last long.
When speculators witness the HUI hitting its lower -2.5 SD band
again in the future, it probably will mark another fantastic
time to deploy fresh new gold-stock speculative positions. Watch
for this event!
On the other hand, the HUI
has managed to hug its upper +2.5 SD line for considerable periods
of time during its major rallies. These episodes are shaded in
red above, and they help to illustrate just how difficult it
is to call a short-term gold-stock interim top using Bollinger
Bands alone. Yes, the HUI did tend to top at SD extremes, but
each interim top happened after a long series of challenges of
the upper Bollinger Band by the HUI.
In a strong bull market, speculators
have no way of knowing in real-time whether a particular challenge
of the upper Bollinger Band is the one that will mark an interim
top or whether the rally will still keep powering higher. As
such, it is not a good idea to liquidate short-term gold-stock
speculations on upper SD-band extremes alone. Bull markets always
tend to surprise and amaze to the upside, and they can run strong
for quite awhile at 2.5 standard deviations above their 50dmas.
From a practical real-world
speculation standpoint, these observations lead to some important
rules for gold-stock speculators to consider when incorporating
Bollinger Bands into their own technical analyses.
First, the HUI's relative position
within its Bollinger Bands tells us for certain whether the HUI
is relatively cheap or relatively dear, but not much more. Your
odds of launching successful gold-stock speculations are highest
when you deploy new capital when the HUI is near its lower SD
band and lowest if you buy when the HUI is approaching the top
of its SD trend pipe. If you want a high-probability-for-success
gold-stock trade, patiently wait to deploy until the HUI is challenging
its lower Bollinger Band.
Second, in secular bull markets,
lower Bollinger Band kisses or breakouts are far more useful
and tradable than upper Bollinger Band ones. Most of the greatest
rallies to date in the HUI erupted soon after the index traded
more than two-and-half standard deviations under its 50dma. Next
time that you witness the HUI 2.5+ SDs below its 50dma, which
is about 180 today, odds are that it will be an excellent time
to deploy fresh capital in gold stocks, especially if key other
technical indicators confirm.
Third, if you are looking for
a specific short-term interim topping signal within a secular
bull market, Bollinger Bands are not the right tool for the job.
The HUI has hugged its upper Bollinger Band with great and long-lasting
affection for much of its bull market to date. While you don't
want to deploy new capital when the HUI is challenging its upper
SD band, neither do you want to sell outright though.
I have long recommended that
my speculator clients, when chasing a bull like this, rely on
increasingly tight stop losses to back them out of trading positions
sans emotions. If you have speculative gold stocks that you are
holding for trading purposes, and the HUI gets up to two-and-half
standard deviations or higher above its 50dma, then you ought
to consider ratcheting up your trailing stop losses.
Prudent stop losses enable
you to ride individual gold uplegs as long as possible, while
vastly limiting the intense emotional challenges involved in
selling. If your stops are not yet hit, you can stay long even
when the HUI and gold stocks look technically overvalued. But
once your stops are hit and the markets close out your positions
for you, remain on the sidelines and patiently wait for another
high-probability buying opportunity. There is no hurry!
One of the greatest things
about the financial markets is that stellar speculation opportunities
are always coming and going. Never fear missing a given deployment
window to launch short-term speculations, since more are always
coming in the future. Being in a "hurry" to speculate
often leads to losses, so just be patient and wait for a great
opportunity like a HUI hovering over two-and-a-half standard
deviations below its 50-day moving average.
Before we move on, there is
one more important point to note in the chart above. So far in
our gold-stock bull to date, each major HUI rally was officially
over and a downleg upon us when the HUI broke decisively below
its white 50dma after each major upleg. White arrows above mark
these episodes in the past couple years.
Today, the HUI is hovering
right above its 50dma again, which is around 225 at the moment.
If the HUI breaks significantly below its 50dma, odds are that
it will then head all the way back down to its 200dma just under
175. If you want to look for a signal that this awesome gold-stock
upleg of 2003 is finally embarking upon its inevitable healthy
bull-market pullback, then watch the HUI relative to its own
50dma very closely in the weeks ahead.
Our next graph takes a shorter-term
perspective, showing the HUI within its 20dma +/-2 SD Bollinger
Bands. Once again though, highlighting the endlessly fascinating
fractal nature of the financial markets, the "rules"
at this short-term scale are virtually identical to what we observed
above.
Naturally this much shorter
20dma Bollinger Band trend pipe is far more volatile and chaotic
than the original 50dma one above, but it underlines the very
same lessons. While great buying opportunities in the HUI universally
happened when it challenged its lower 20dma Bollinger Band, times
to sell were ambiguous since the HUI often hugged its upper +2
SD band.
A speculator employing 20dma
SD bands in his HUI trading has an excellent opportunity for
big long profits if he deploys gold-stock speculative capital
only when the HUI is beaten down to two or more standard deviations
under its 20dma. Conversely, when the HUI rebounds and launches
back up towards its upper band, it is a good time to raise your
stops and let the markets close out your speculative positions
for you.
While odds are that any important
HUI pullback will trigger off of a +2 SD extreme anomaly, it
is always hard to tell whether it will be today's +2 SD high
or next week's or next month's. The yellow-shaded zones above
show the large areas where the galloping HUI traded in lockstep
with its upper Bollinger Band. As such, just as I noted above,
the HUI Bollinger Bands are far more useful for discerning great
moments to buy rather than attempting to divine the right time
to sell into short-term interim tops.
Now zooming in and combining
our first two graphs for the 2003-to-date period alone, the interactions
of both long-term and intermediate term Bollinger Bands and the
HUI offer even more insights into the practical utility of these
standard-deviation bands. While not primary trading indicators
like the Relative HUI, the Bollinger Bands are able to do a fantastic
job of illuminating the balance of probabilities in favor of
or against an imminent and tradable short-term trend change.
Tying it all together, watching
the HUI relative to its long and intermediate-term Bollinger
Bands in 2003 would have proven quite profitable for gold-stock
speculators. Let's run through a 2003 play-by-play analysis
In January, the HUI hit its
short-term 20dma +2 SD Bollinger Band, letting speculators know
that it was relatively richly valued from an intermediate-term
perspective. Speculators know that an upper hit is not necessarily
a strong sell signal in a powerful bull market, so they would
have merely raised their trailing stop losses and upped their
vigilance in January.
And if they weren't stopped
out earlier, when the HUI broke decisively below its own 50dma
in February that was a hard technical signal that the previous
upleg was most probably over. With the HUI drifting lower and
lower towards both of its lower Bollinger Bands, prudent speculators
could have bought when it traded under its 200dma, as our clients
and we did, or they could have waited until the HUI bounced off
of its lower Bollinger Bands. This mid-March time frame proved
to be close to the ideal moment to buy gold-stock speculations
for the HUI's fantastic 2003 bull-market upleg!
Once probabilities favored
the long side again by mid-March, the HUI began to gradually
climb higher, delighting speculators. By June it had pierced
its 20dma +2 SD line, but couldn't quite manage to break above
its 50dma +2.5 SD line. Either way, this was a caution signal
especially over the shorter-term, to make sure that one's stop
losses were properly set and ready for a pullback.
The pullback did indeed come,
but it was fairly minor. It bounced off of its lower 20dma Bollinger
Band in the middle of July. Even more importantly however, the
HUI's 50dma held. In technical analysis, it is useful to think
in terms of The 2% Rule. If you are watching a key support level,
like the HUI's 50dma, don't consider it "decisively"
broken until the HUI closes more than 2% under it. This 2% rule
helps filter out meaningless short-term market noise and enabled
speculators to hold in July even while the HUI's 50dma was being
actively challenged.
From July to September, the
HUI soared! It was one heck of a ride and everyone long gold
stocks was blessed with some fantastic profits. In late September
the HUI bounced off of its 20dma +2 SD band and headed south,
but its pullback ended at its key 50dma which also happened to
be its lower 20dma -2 SD Bollinger Band at the time. This pullback
was sharp, and did stop us out of some of our own positions,
but the 50dma held so this major gold-stock upleg was still technically
alive.
From its early October rebound,
the HUI soared until late November. It has pulled back sharply
again in recent weeks since then. While it is probably not wise
to use the upper Bollinger Bands alone as primary sell signals,
our other primary technical indicators like the Gold 50/200 MACD
and Relative HUI did and do suggest that a short-term pullback
in gold stocks back down towards their 200dmas is highly probable.
But the real acid test for the longevity of our current upleg
is yet to come.
If the HUI does not bounce
at its 50dma, around 225 today, and it trades decisively under
this white line, then odds are that our current gold-stock upleg
is over. Every single time in our awesome young gold-stock bull
to date when the HUI's 50dma decisively fell, it was on a major
pullback back down towards the index's 200dma.
Only time will tell whether
the HUI's 50dma will hold again as support in the weeks ahead
or not, but if it doesn't then the good news is that a fantastic
new buying opportunity is rapidly approaching, when the HUI careens
back down towards its 200dma and its lower 50dma -2.5 SD Bollinger
Band. We haven't witnessed a similar magnificent buying opportunity
since March so I am certainly looking forward to seeing these
glorious technical gold-stock tidings once again.
If speculating in gold stocks
is your game and you are interested in which potential stocks
to consider buying for the next major gold-stock upleg after
the pullback, you may wish to check out the current December
issue of our acclaimed Zeal Intelligence monthly newsletter.
In this issue, titled "Blue-Chip Golds," we ran all
of the elite gold stocks of the HUI and XAU through technical
screens to find the best-performing and most-promising candidates
for serious fundamental analysis.
In the upcoming January issue
for our subscribers, I intend to continue these studies and farther
advance our technical and fundamental preparation for the next
major gold-stock upleg. As always, new subscribers will receive
a complimentary electronic copy of the current December issue
of ZI and your subscription will start with January's dispatch.
Please join us today!
Bollinger Bands, even though
they are not necessarily designed to be primary trading signals,
are very valuable to gold-stock speculators. They help us to
discern in real-time when the HUI happens to be priced relatively
high or low, excellent information to possess.
The HUI Bollinger Bands also
help us to understand when stellar buying opportunities exist
when the HUI is crowding its lower standard-deviation bands.
Since buying low is a crucial half of this whole speculation
ballgame, gold-stock speculators really ought to pay attention
to the HUI Bollinger Bands.
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
December 19, 2003
So how can you profit
from this information? We publish an acclaimed monthly newsletter,
Zeal
Intelligence,
that details exactly what we are doing in terms of actual stock
and options trading based on all the lessons we have learned
in our market research. Please consider joining us each month
for tactical trading details and more in our premium Zeal
Intelligence service.
Copyright ©2000-2003
Zeal Research All Rights Reserved (www.ZealLLC.com)
321gold Inc
ref: 04296
|