Standard deviation channels can help simplify identifying potential trends in futures by providing a bird's eye view.
Know how standard deviation channels work
Understand how to plot standard deviation channels
Know how to use standard deviation channels when analyzing futures markets
For many, the thought of trading futures may suggest aggressive trading—getting in and out of positions several times a day. In reality, it’s possible to be a more deliberate futures trader. Leave the aggressive trading to those who are extremely experienced.
Futures contracts are known for volatile moves—whether it’s a reaction to a news release, seasonal tendencies, or a certain time during the trading day such as the open or close. Should you chase each volatile trade?
Not necessarily. You can be patient and wait for volatility before you open a position. And you don’t have to close that position the same day you open it. Although no one approach or trading system can guarantee anything in trading, there are some indicators you can apply that might help you identify when prices could be volatile.
One such indicator is standard deviation channels. They're three straight lines on your chart. The middle line marks the linear regression, while the upper and lower lines are standard deviations above and below the middle line. The nice thing is, you don’t need to do all those calculations; you can place these channels on your chart (see Figure 1). Just fire up your thinkorswim®platform from TD Ameritrade and bring up the Charts tab.
Figure 1 shows channels for one (blue) and two (red) standard deviations plotted around the linear regression line (yellow). These lines or channels measure volatility, or how far price is away from its mean.
We won’t get into the specifics of calculating standard deviations. But it’s helpful to know that:
Generally speaking, when prices trade above or below the channels for one, two, or three standard deviations, it could signal a potential reversal. On the daily price chart in Figure 1, you can see that /ES generally moves within the one-standard-deviation bands for the most part. But there are times when it moves above and below those bands, and when that happens, price tends to revert back.
That’s not to say that you should trade whenever price moves outside the standard deviation range. But it can be helpful to be aware of it.
The further price moves away from the mean, the more likely it is to be volatile. If you were to pull up an intraday chart of /ES, you’d likely see price moving outside of both one- and two-standard-deviation channels several times during the trading day. Try it out on other contracts, such as crude oil (/CL) and gold (/GC). Knowing how price moves between the standard deviation channels is sure to lift your market awareness up a notch.
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Jayanthi Gopalakrishnan is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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