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Standard Error Bands
The basis of Standard Error Bands is standard error levels located higher or lower than Linear Regression Indicator. Standard Error Bands developed by Jon Anderson are the variation of envelope. That is why their outlook is close to Bollinger Bands though their calculation differs. The plotting of Bollinger Bands is made a standard deviation higher or lower than a moving average, whether the lines drawn below or above linear regression plot are Standard Error Bands.
The recommendations of Andersen are following values: the number of periods is "21," smoothing at a 3-day simple moving average, and standard errors is "2." Another note is that unreliable results are made by taking short time frames.
Standard Error of the security gives the ground for Standard Error Bands spacing. That is why the reliable trend can be seen when the distance between the bands is very tight. Wide fluctuations and price volatility is expected when the distance is big. The increasing distance after being small is the sign of the trend losing its strength and a possible reversal.
- Strong trend is indicated by tight bands.
- Wide distance between prices gives the freedom for prices fluctuations.
- Increasing distance between bands can be the sign of trend weakening and possible reversal.
- Prices follow the direction of the bands reversed after the lost trend.
- Standard Error Bands makes a good combination with the r-squared indicator. A reliable trend existence is confirmed by high r-squared value along with low bands' distance. A combination of low r-squared value and wide bands' distance shows the trend weakening.
Generally, the Standard Error Bands attempts to show the trend and its volatility. This indicator is resulted in 3 plots. The linear regression line showing the 21-period ending value is the middle one.
Two standard errors added to the regression line's ending value result in the upper standard error band (the upper plot).
The subtraction of two standard errors from the linear regression line's end value creates the lower standard error band (the lower plot). Closing price may greatly influence the line values as well as error bands. That is why it is necessary to draw the three bar (period) simple moving average of the ending value of the regression line and the standard errors.
Standard Error Bands have much in common with Bollinger bands, though their interpretation differs. Trend directions along with its volatility are represented by Standard Error Bands whether the indication of Bollinger bands is average plotted price volatility.
One of the usage tactics of Standard Error Bands is monitoring the distance reduction at the moment of both upward and downward price movements. An easy price trend is supposed to occur in case this situation takes place. A strong trend keeps the bands at the close distance. The Linear Regression follows the increasing or decreasing trend direction. The price reduction is indicated by widening Bands. A trend completion may be signalized by the following Linear Regression decrease.