Standard Error Bands

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Description

Standard Error Bands are a type of Envelope developed by Jon Andersen. They are similar to Bollinger Bands in appearance, but they are calculated and interpreted quite differently. Where Bollinger Bands are plotted at standard deviation levels above and below a moving average, Standard Error Bands are plotted at standard error levels above and below a linear regression plot. Click here for a definition of standard error.

For information on other channel-based line studies, see Envelopes, Raff Regression Channels, Standard Deviation Channels, and Standard Error Channels.

Interpretation

When displaying Standard Error Bands, you are prompted to enter the number of periods in the bands and the number of standard errors between the bands and the linear regression line. Mr. Andersen recommends default values of "21" for the number of periods, a 3-day simple moving average for the smoothing, and "2" standard errors. He also notes that very short time frames tend to produce unreliable results.

MetaStock plots Standard Error Bands on the security's prices or indicator. These interpretational comments refer to bands on the security's closing price.

Because the spacing between Standard Error Bands is based on the standard error of the security, the bands widen when the volatility around the current trend increases, and contract when volatility around the current trend decreases.

Since Standard Error Bands are statistically based, other statistical indicators such as r-squared, Standard Error, Linear Regression, etc. work well for trade confirmation.

Mr. Andersen notes the following characteristics of Standard Error Bands.

• Tight bands are an indication of a strong trend.
• Prices tend to bounce between the bands when the bands are wide.
• Tight bands followed by a widening of the bands may indicate the exhaustion of a trend and a possible reversal.
• When the bands reverse direction after an exhausted trend, prices tend to move in the direction of the bands.
• The r-squared indicator works well in combination with Standard Error Bands. A high r-squared value combined with tight bands confirms a strong trend. A low r-squared value combined with wide bands confirms that prices are consolidating.