Here is a powerful method to track current trends and spot reversals – accurately and consistently.
This method combines two separate indicators, the Bollinger Bands (BB) and the t-line (trend line).
Bollinger Bands contains three parts. First is a 20-period simple moving average. Second is the upper band and third is the lower band. Both of these are two standard deviations away from the middle band. This sets up a powerful and visual summary of historical volatility. Thus, price is unlikely to trade above the upper band or below the lower band. When price does move outside of these ranges, it retreats back into range very quickly. So BB is a great “probability matrix” to time and control both entry and exit.
The T-line is an 8-day exponential moving average of price that yields surprisingly reliable signals for changes in price direction. The general rule is that when price is above the t-line, it remains bullish until it crosses below and closes for at least two sessions. This sets up a bearish reversal. When price is below the t-line, the prevailing bearish trend continues until price crosses above and closes above for at least two consecutive sessions.
Taken apart, BB and the t-line are powerful on their own. However, when used in combination, you set up a very powerful dynamic trading range, making it easy to spot when a trend ends. As price advance, the BB upper band represents resistance and the t-line is support. When prices are moving down, the t-line is resistance and the BB lower band is support.
The chart for Amazon.com (AMZN) demonstrates the many types of continuation and exit signals this combination provides.
In May, price was trending higher with considerable strength and many gaps. The retracements occurring in the first week could have been reversals, except for one important signal: Price remained above the t-line from late April $600 per share) all the way up to mid-May ($720 per share). As long as price did not move below the t-line, this bull trend continued. This was further supported by the BB upper band, marking dynamic resistance.
Price did close below the t-line toward the end of May, but immediately crosses above at the $700 price level and continued up to about $730. The second crossover was bearish, marking the move of price below the t-line. The third crossover took price back into bullish territory, this time marking the end to a three-week consolidation trend and the start of a new bullish move.
The most dramatic move of all was seen in the crossover in the second week of September. With an extremely narrow trading range, price moved up 80 points in one month, from $760 to $840. How would you know when this bull trend would end? Once again, resistance was marked by the upper band of BB, and support by the t-line.
This did not end until price once again fell below the t-line, moving from about $830 down to $813. At the end of the chart, the trend was bearish and likely to continue until the price once again turned up above the t-line.
This combined BB and t-line dynamic trend track is so reliable that it can be used effectively in two ways. First, as shown at the beginning of the chart, it distinguished between retracement (not moving across the t-line) and reversal. Second, actual crossover is the signal point for leaving a current trade and taking profits, or for entering a new trend based on the newly revised price direction.
This solves the most disturbing aspect of short-term options trading. When do you exit a trade? Even with the lack of price-specific reversal signals, the combined use of BB and the t-line is a powerful and reliable system to improve timing.