Standard Error Bands can show trend direction and price volatility around the trend. There are three components to Standard Error Bands:
- Smoothed Linear Regression Line: Generally a 21-period linear regression curve that is smoothed by a 3-period simple moving average
- Upper Standard Error Band: The linear regression line plus 2 standard errors.
- Lower Standard Error Band: The linear regression line minus 2 standard errors.
Standard Error Bands are plotted on the chart of Wal-Mart (WMT) stock below:
Potential Intepretations of Standard Error Bands
- When price is trending and the Standard Error Bands are contracting, then the price has strength and may continue to trend.
- When the Standard Error Bands begin to expand, then the trend may be ending and a trader might expect the markets either to consolidate into a non-trending market or reverse trend.
Standard Error Bands are used by some traders to determine the strength of trend and potential reversals of trend or consolidation of prices. Standard Error Bands are quite unique in their interpretation, but there are other price-band concepts that are popular such as Bollinger Bands (see: Bollinger Bands), Keltner Channels (see: Keltner Channels), and Moving Average Envelopes (see: Moving Average Envelopes).
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