Tuesday, February 05, 2008

Standard Deviation Channel

I recently read article about, about standard deviation channel, (which as you may already know is one of my favorite indicators), and I was shocked, although author of this article explained what standard deviation channel is in mathematics but it had very little to do with Forex or any other financial market. Furthermore, I read other articles about standard deviation channels and what I found out is that they all were giving useless information to readers, so here is the right way to use standard deviation channel.

First of all, authors suggest that, when price will reach upper line, it is time to take SHORT position and vice versa, when price will reach lower line you should take LONG position because market is oversold.

This is true only if market is trending. It is quite safe to treat then lower line as support line and upper line as resistance line, and more over (depending on your standard deviation channel settings) 95% of price movement will happen between this two lines, as long as market is trending. The obvious question here is how to tell if Forex is trending, but this question is beyond the scope of this article, at least for now J.

What I like about standard deviation is that it allows to easily determine trend, you just need to draw channel over the selected period of time and that’s it, you have detected trend. However to use this indicator efficiently you need some experience, ideally you should see channel on the chart before you draw any lines on it. If you don’t see it, then do not worry it is all about experience.

How to use correctly Standard Deviation Channel

If market is in uptrend, you should take ONLY long positions, when price will reach lower line. Never take SHORT position in uptrend when the price will reach upper line, that do NOT mean that market is overbought, in uptrend price can easily go waaay over upper line and hit STOP LOSS, of trader who was stupid enough to take SHORT position in bull market.

Obviously, the opposite goes for market in downtrend, do not take long positions on lower line, NEVER.

Most importantly, this indicator is called standard deviation channel and you should use it only with CHANNELS not with any random piece of chart, below is the stock market chart with two correctly drawn channels.