New Research: Essay Three
© Andrew Coles - no unauthorized reproduction of this work
The aim of this essay is to introduce a new indicator to the MIDAS canon I have called the MIDAS/AC Normal Deviation Bands.
Work on this new indicator has been motivated by the limitations of the MIDAS Standard Deviation Bands, an indicator that was the focus of my Chapter 15 of the MIDAS book.
This new indicator is based on a formula that has evolved from the original formula of the indicator in Chapter 15 in several ways and the end result is now quite different from that formula. The consequence is a much better indicator which avoids the limitations of its predecessor and can be applied quite extensively to normal trendlike conditions.
It is not the conclusion of this essay that the MIDAS Standard Deviation Bands should be scrapped in favour of the new indicator. What I wish to emphasize far more than was stressed in the book is that the MIDAS Standard Deviation Bands have very limited applicability to very uncommon price patterns. This is the result of the indicator’s formula, which causes the Standard Deviation Bands to fan out (displace) from price much too quickly and much too far for them to be used extensively on normal price movement.
I’ll begin the next section of this essay by highlighting the limitations of the Standard Deviation Bands in Chapter 15, while also briefly discussing the type of very uncommon chart patterns it is limited to.
Limitations of the MIDAS Standard Deviation Bands in my Chapter 15 of the Book
Although it has been an overriding goal of the MIDAS project to create an analysis framework applicable to every possible financial chart pattern through new variations of curves and new indicators, I have always been unhappy with the Standard Deviation Bands due to their extremely limited application. As noted in the introduction, this limited application is caused by the tendency of the bands (a) to fan out from price very rapidly, and (b) to do so while fanning out (or displacing) from price much too far. As a result, the indicator has never been applicable to normal trending environments.
Because of this fanning problem, there are only three types of chart pattern where this indicator can be put to use. All three are characterised by wide oscillations or swing highs and lows that are often trendless. The three types of pattern are:
Broadening Formations are very uncommon whether they appear as reversal or continuation patterns. Sharply angular moves are much more common than Broadening Formations but they too are often volatile and frequently unlike normal trending conditions.
For the benefit of readers unfamiliar with Broadening Formations and particularly the sharp angular move in (c), Figure 1, Figure 2, and Figure 3 respectively illustrate these patterns, beginning with Broadening Tops and Broadening Bottoms in Figure 1. (NB. All galleries in this essay will require users to have Flash installed on their computers and can be paused at any time.)
Figure 1: Broadening Top and Broadening Bottom formations in futures, stocks, and cash forex
In Figure 2 below we see two Broadening Formation continuation patterns resembling an inverse Symmetrical Triangle. Sometimes these patterns can last days or weeks, and sometimes years, as in the case of the three year pattern in Cocoa futures below. In Chapter 15 most of my illustrations were intraday futures price patterns.
Figure 2: Two Broadening continuation patterns in stocks and commodities
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