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Hey this is Sasha Evdakov and welcome to another episode of let’s talk stocks, episode number 85, why stocks snap back, a little bit on retracements and Bollinger band basics.
In this lesson, what we’ll really focus on is more so why stocks snap back, and then of course more on Bollinger bands, a little bit on the basics of it.
We’ll talk a little bit on retracements because it kind of fits together, but we’ve talked about retracements and Fibonacci sequences in other modules, so in here, what I’d like to do is concentrate a little more on Bollinger bands, the basics behind them, but again, we’re only covering the basics.
I’ll probably need to do a more in depth, full lesson on just Bollinger bands. However, I think it’s more important that you concentrate and focus on price action, behavior, the volume of the stock, and the overall bigger picture, because that in the end matters much more.
The Bollinger bands are still lagging indicators, and it’s just an indicator that you can glance over. All those other indicators that are fancy and popular, they’re mostly lagging indicators and they’re driven from the price, the price spread, the range of that price, where it opens and closes, and it comes together and uses also volume and the basics behind that stock, and it creates a little bit of an indicator for you.
So in essence, if you know how to read price, the way that prices move, the range of those bars along with volume, you have all the indicators that you need. You really do.
We’ll just cover a little bit of these Bollinger bands and just give you some basics and then maybe in the future I’ll do a more in depth analysis of Bollinger bands.
Before we get there, I do want to share with you that the website here does have now mobile responsive navigation, so for those of you that are using this on iPads and so forth, if you go ahead and now you can see a mobile menu that works a little bit better.
Typically the websites and the things that we get into the websites, fixing things here and there, we try our best, but my main focus is usually to produce more educational content that have a fancier website.
In either case, now this works pretty well and you can go ahead and use that on your devices, your other smaller devices and it shouldn’t have a problem.
In this example what I’d like to do is really concentrate on tesla here, just to illustrate the example of the retracements, I think it’s an easy example to go through, and I’ll do that after I show you really what we were going on and talking about with one of the people here on social media.
When you look at social media here, you can see that somebody asked me about the tesla stock, and this was, again, a public conversation o twitter, so when they asked me about tesla, I mentioned that you have some support here at the $205 level, the $200 and the $190 are levels to watch as well, and this was 14 days ago.
If we backtrack this, and you can see that Michael Perry looks like he was right on this one, up $6 at 2011 right there. So if we back track these 14 days, and we take it back 14 days right around there, this is when this big spike was coming down on tesla.
Why do stocks snap back?
How did I come up with the figure, how did I read this chart and how does it make sense to choose these figures? Well, before even knowing the figure, you have to understand how stocks move, so why do they snap back? Well, they snap back because people buy their shares back.
If you’re doing a long position, let’s just say you’re going to the long side right here, you’re going to have little pull backs, and you may get a little power higher, and then you’ll have a little pull back, so why do you get these pull backs?
You get these pull backs because people take profits, they take their money off the table, because they get a little too excited, the risk becomes more in the other direction, so you take some profits. Or you also have shorts now stepping in, when you have short people stepping in, selling the stock first, buying it back latter, that also triggers more sell orders.
Rubber band effect
This happens here, when you look at the S&P 500, this happens the same thing on the way up. So when we have, let’s just say, from January - February, these lows, the stocks pop over here, and then they go ahead and bull back a little bit, they pop a little higher, they pull back, so basically it’s a rubber bad effect.
And if you look at it overall, and you look at it on a moving average, which is this moving average here that we have, you can see that the moving average, averages thing together, and if I really just hide this, let me just go ahead and hide that, you can see that now, you can still get a rough moving average without that indicator, now, I put it there for a guideline, I use the 20 day, why do I use the 20 day? Again, I emphasize because it’s 20 trading days in a month.
If you get rid of that indicator, I bet you can guess where that average, or moving average is going to go. So if you learn to read the prices, you can still do this in your head, you don’t need this indicator, you don’t need to clutter your screen. But if you put it there, it gives you a more precise average.
Stocks move to the average
If we look at this, you can see that once we get stretched too far in one direction, stocks come back to that average, so they snap back, so let’s say we get too far extended over here in November, beyond the average speed, we’re over extended, then we snap back in the other direction. And if we snap back too far in the short side or in the bearish side, we snap back the other way.
You’re basically doing this rubber band effect, I’ve talked about this rubber band effect that happens that you get this sapping action.
If you get a major snap down, like we had here in January, you’re going to have an even wilder snap back higher, so you had this little January pop, but really, the main pop that you had, if you look at it on a bigger picture, the main pop that you had, here’s the weekly chart, basically what happens here on this chart is, you had this moving average that was kind of going, but then you had a major snap down in January, and then you had that major snap back up again in February - March, and now you’re going to get a little bit snap back down to that level again, to kind of get closer to that moving average.
Those of you who have watched that episode 83, 82, I talked about that I was more short and going into short areas, meaning trading more short, and there was a reason for that. So review those videos if you haven’t yet, or if you haven’t watched those, but you get to see how these things roll over, and I really break it down in detail there.
But understand that basically stocks, once they get too far extended, they’ll snap back and go the other way, because people get profits, because it’s just normal and healthy, they just can’t continue to go straight up, it’s not healthy, not normal.
As I mentioned before in the past, a more healthy approach would be something along this angle, this is a little bit of a slower approach, if you have like a 20 degree angle upwards, it’s a slower approach. 40 degree, 30-40 degree is maybe more healthy.
If you get something like a 60, 70, 80 degree approach, you’re looking for a quicker pullback, and the faster they go up, the harder they come back down, because there’s more people on that side of that trade, so that’s one thing you need to prepare.
How far can a stock pull back?
We’ve talked in the past, how far can a stock retrace, or how far can it pull back.
Just to give you some quick insight, basic pullback, basic retracement, a stock can retrace based on the swing points. If we look at tesla, from February all the way up until April, a basic pullback is 50%, that is a healthy percentage and that means nothing is wrong with the stock. Can it go a little bit further? Absolutely, can it go a little bit less? Absolutely.
But if you take your Fibonacci sequence, which we’ve talked about in the past, and you draw this line right here, which is the number that I came up with, and really there’s a calculation to do this, you take the lows of here, and the highs up here, and you can take a look at it in the green course, stock trading foundations, which will give you the precise levels of the Fibonacci sequences, and this is what I do on a calculated level.
This is just a quick guess, and these things help you draw them out, but if you want the precise figure, you do this on a calculator, or you do this in your head.
Typically taking 61.8% of something is not as precise, for me I just have a quick calculator that I do it on, but for you, if you can do it all in your head, by all means go ahead and do that.
When you take this retracement, this gives you a rough guideline with these Fibonacci tool and you can draw it out, and this is how I came up with that number, a basic, healthy retracement to that 50% level, would be right around that $205.
And this is exactly what I mention right here, some support at the $205 level, you even have some at $200 and the $190 levels are the ones to watch.
That’s how I came up with this number. Now, this stock, you’re also paying attention to how far is it coming in.mHow fast is it coming in to these levels?
Because we know stocks are like rubber bands, I’m watching these highs came in to these levels, rejected it, so it’s going to be a rubber band, we also known that it’s further away from this moving average, so we know it’s going to snap back.
And how much is it going to snap back? How far accelerated? Is it accelerated at an 80 degree angle? A 40 degree angle? Maybe a 30 degree angle? How far is it accelerated? So that’s how it tells me if that snap back is only going to be light and minor, maybe it’ll be light like at the 38% level or so. Or is it going to be like a 50% level?
In this case, because it was a little accelerated, tells me 50% rather than that 38.2% level, because it already was breaking that anyway, and in fact, it could’ve gotten into that 190 level of 61.8%.
And if you take a look at this, you can also see it hitting some predominant swing points over here in January of 2015 so that’s also something to consider.
Again remember, these are just basic tools and guidelines, you do your analysis, you put it together and you start evaluating what is your risk to reward? Where are the probabilities that are in your favor? This is what I do, this is what I do and I look at, where is the volume? How is the energy of that stock going? How far extended is it? And it’s all about putting hose puzzle pieces together.
Don’t complicate your life
It’s not about one indicator, one thing that’s going to tell me the magic bullet or recipe like stochastic, RSI, MACD, all that stuff. No, because they all work off of volume, price, price spread, price action, they all work off of that, that’s what they work off of, so if you get this, what I just explained, you’re going to get everything else.
You don’t need to make your life more complicated. If you got this as a foundational level, then I start to maybe look at things at a Bollinger band, maybe one or two other indicators that I might go in detail about in the future, but right now, I don’t want to confuse you, so here, I’m just going to touch base a little bit of Bollinger bands here for you.
With Bollinger bands, it basically takes a statistical evaluation, and you can see how it relates to moving averages as well. So what it does is, it tries to contain the probabilities that your stock, depending on the range that you set up, but let’s just say 98% of that stock is going to be contained in these range or these bands, and you can set them up, again, you have two standard deviations, if you don’t know statistics, you might want to do a quick little review about standard deviations. But I’ll try and touch base on it here in a second. You have a period, again 20 trading days.
And then I do my standard deviation, I keep it on a simple moving average, you can do exponential but I keep it simple. But basically if you look at standard deviation, I keep it at 2 standard deviations here on this Bollinger band.
If you don’t know what standard deviation is, here’s a quick little image, and you can just look up standard deviation on Google images, read a little more about it.
Again, this is something I’d have to go in a full 40-50 minute lesson about to get in it really tackle it, but again, this is just a little taste of what it’s about, this is not very in depth or in as much detail as I’d like to go into it, but it’ll give you a rough idea.
Basically, you can see here, I have a two standard deviation a model right here, and then you have a three standard deviation, so basically, this is a bell curve, and the percentage or the likelihood of something working out is within this range, and you have these end points and the end points over here, on the left and right, where if you think about the stock going up or down, it’s going to fall somewhere in here.
The statistical, this is statistics really, the statistical deviation that the price is going to contain in this area, meaning simple turns, what is the probability, or what is the chance of that stock being in that range? One standard deviation is going to put it at 68.3%, if I do two standard deviation, it’s a 95.5% chance.
And if I do three, it’s a 99.7% chance that the data is going to be contained. So again, look up standard deviation on Google images and it’ll give you a rough idea of how these things work and read about it, again, this is something that we can go in much more detail about, but gives you a rough idea.
Don’t make your decisions based on Bollinger bands
Anyways, here we have a 20 day period, again, that’s our moving average, and two standard deviations, so again, we are trying to contain 95% roughly, 95% of the price levels in that range. But again this is a rough guideline, this is complementary to all the other things, this isn’t something where I make my trade decisions based off of that.
Let me be clear again, big warning here, I don’t make trade decisions based on my Bollinger bands, because stocks can go much higher or much lower beyond Bollinger bands, and they can totally switch around, so that’s one thing that you want to be very cautious about.
For example, if you’re starting to change this to let’s say, three standard deviations, that means 98% of the data is going to be contained in there, now you can see certain times it doesn’t happen, and that usually happens due to earnings and some other factors, like we had in August-September time in 2015.
When we look at two standard deviations, we got 95% of the data, and here you can see a few outliers, that means, chances are it’s going to snap back, it’s a little extended, but it’s not always the case, you also have to pay close attention to the volume, the energy that the stock is doing and the price.
Because for example, here that we’ve had on Thursday 5th 2016, you got a break of that Bollinger band dramatically and it still continued lower for a few days and then the stock continued to pop a little bit, and that is simply because of other factors.
Again this is just a guideline of containment, with Bollinger bands they’re basically related to, let’s just say this moving average, it just makes things easier, because if you see this moving average, you can basically draw out the Bollinger bands. The wider, the more volatile the price risk, or the price is.
You can see, as you get more volatile, as the price spread becomes bigger, these Bollinger bands expand, so when we have sell offs, typically they’ll widen because you have wilder snapbacks, and as prices don’t move around much, they get a little more contained, they get a little tighter, so that’s what happens, and as you start this massive sell off, you probably get wider bands, and that is simply to contain the prices.
Bollinger bands move with the averages
So even without these Bollinger bands, you can go ahead and really kind of draw those out yourself. So for example, if I was just to draw the Bollinger bands out, I could probably just do it with the moving average, again, I’d be containing my prices, and you can kind of draw out your Bollinger bands, you don’t really need to have Bollinger bands to really understand where prices are over extended on your stock. Simply just having a moving average or just looking at the price, the volume, the behavior, gets you insights to how far extended they are.
But this is what these types of indicators do, they give you insight, but people use them without really understanding the whole core, the foundation behind them, they use them and they make trade decisions off of it.
Make your decisions based on the fundamentals
When we look at a stock like a tesla, we start looking at it, you can see that over here, this Bollinger band, will tell you that we’re too far extended, and then you would think, we’re going to snap back, but that’s the problem, people make their decisions solely, or only based on this one indicator, and they don’t take into account the other factors and the other things that are even the core of the chart, that are the most fundamental things of the stock, which is the price, the energy, and how it’s moving, acting, behaving, the volume. They don’t take into account the energy, the flow of momentum and energy in that stock.
Here, you can see, we hit that Bollinger band, we’re on the outer part of it, and you would think we’re going to snap back, but we don’t and we continue moving lower, so here for me, what I do, the way I look at this is, are we a little extended?
If the answer is yes, then I would say, we should have a little consolidation or snap back soon, or we could get a little major drop in prices, which is what’s going to happen, which is what really happened.
Bollinger bands don’t always work out
You can see that these Bollinger bands are not always going to work out, so look at it over here, if you look at the S&P in august of 2015. How we just boom, the Bollinger bands widen out dramatically and we were way down an extra 14-15 points on the S&P, we just snapped down and took those stocks right out, and that can happen.
Especially with a more volatile stock, like a tesla. And that’s why if you know and understand the core of how far things are extended, where they’re coming into, how fast they’re coming into is more important, but when you start getting into Bollinger bands, it gives you just another guideline.
Again, retracements, we’ve discussed in the past, reviewed that, but retracements give you some basic key levels to watch, of where the potential support, resistance levels could be, how far that pull back could be, again, and even looking here, you’re watching at how far that snapback could be as well.
You’re watching those different things at how far snap backs could be, and so forth, and that’s what you’re looking at. But really you’re taking into account multiple things, and then you’re just glancing over these other little subtle things from time to time, that’s how you add in indicators.
All you need is price and volume
You don’t make decisions solely on these MACD Stochastic, RSIs, or Bollinger bands, you’re glancing over them to confirm your analysis, because really, if I took all this, off, even the moving average, the only thing I need to trade, the only thing I need to trade is price and volume, what more do you need?
You don’t need anything else, because you can drive everything else from that, you can drive the moving average from that, you can do it manually, these things help you, like a moving average like this will help you to see that moving average, Bollinger band will help you to give you a rough guideline, there’s a formula that’s done and you can look that up, it gives you a guideline of where things are overextended, either to the upside or to the downside.
So if you’re coming into these highs, you can see that right here, we’re coming into these highs, you would think that this level, you would say, ok we’re ready for a pull back, and you do get a little pull back, but that doesn’t mean stocks can’t go much higher, because you have this resistance level up there.
That’s why you can’t put as much emphasis on these things, you have to look at the bigger picture, and that’s really what I wanted to share with you, is that stocks they snap back, they pop back, they retrace, and you’re using the core, the fundamentals to make your trading decisions, and then all these other indicators that you’re using are just another guide, it’s another tool to give you a quick validation to your analysis and to see that things are moving in an appropriate direction.
But you shouldn’t be emphasizing all your decision making for trading stocks based on one single indicator like these fancy indicators, these are lagging indicators.
Really you need to be making your decisions based on this and the core fundamental analysis that you do, the fundamental analysis meaning, the foundational analysis between price, action, the price spread, the range, meaning the open and the close price, that’s the range, that’s the price spread, that’s what you’re doing your analysis on, and volume and how that ties in together.
And then you tie that into glancing over, let’s say a Bollinger band, or, a William advancing declining, all these different things, MACD stochastic, and you glance at them, you pick one that works for you, you don’t’ have to use Bollinger bands, you can use this and that.
I’m just using Bollinger bands right now as an example to give you some insight because it’s an easy one to explain and for people to understand that it’s a little too far extended or it’s a little too far oversold, either overbought or oversold, so you come back to this moving average, but you can choose either RSI, you can choose MACD stochastic, you can choose one that works for you that you like that you can relate to, but again, you’re just glancing over those things, rather than making full trading decisions off of them
I hope that was a little bit helpful, I think I’m going to go ahead and put it in my notes to do a more in-depth lesson on Bollinger bands that we can do sometime in the future, maybe in the next month or so, and that way you can get some real in-depth analysis on how to properly use them, and really get some insight, maybe along with some other indicators in the future as well.
Bollinger bands are lagging inicators
I don’t like to over emphasize these things, because the problem is, I find too many people get stuck on these indicators so much that it really hurts their trading, they put too much emphasis on them and it burns them, it actually kills their account, because they’re lagging indicators, remember, these Bollinger bands are behind the real price action, they’re behind the real time trades, because they average prices together, just like the moving average, it’s a little behind the current price.
That’s why you have to learn the other core items first and then you can tie this in, so don’t try to jump into all these fancy indicators, if you’re the one trading, if you just started trading three to six months ago, and you’re already using MACD stochastic, Bollinger bands, and they’re all in your graph, clear it, clear it all out, all you need is volume, all you need is price, and learn to read the charts correctly in a simple fashion, I know it may sound weird, but I did the exact same thing in the past, where I had some many things on the screen, it confused me, I didn’t know what I was trading off of.
Keep it simple
This is really what you want to watch. keep it simple, to the point where you got it and you understand it, because all those things come from this, they come from that price, they come from that price spread, the behavior of the stock and really the volume, so learn to read that and it will turn your trading around 180 degrees, if you’re negative, you’ve been losing money, it’s going to turn it around, and once you understand it, you’ll be profitable, completely around. And that’s what it does when you really understand something, that’s what it does to your trading.
I hope this was helpful, you get it, you understand it, a little more about these indicators, how they work, how they operate, again, we’ll talk more about Bollinger bands in another lesson, but we’ll just really concentrate on them, and maybe another indicator.
As far as the “20 rules for investing success” book, I do have it ready, it is finished, I’m just waiting for Ryan to wrap it up for you, it’s going to be for free on kindle, so he’s just converting that book, so probably next week we’ll get it out, and it’ll be free on kindle, I think they do like a 3 or 4 day promotion there, so we’ll do that promotion, and then after that, it’ll be free on PDF, so you don’t have to worry about it, if you miss it, but if you want to get it on kindle it’ll be available that first week on kindle first, and then the week after on PDF, so we just need to wrap it up in the sense of uploading it in the kindle format, in their file format system that thy want, and once it’s up I’ll let you know and you can go ahead and download that book. Simple, short little book, absolutely free, won’t cost you anything, and just for being a part of the newsletter.
Also, as far as these video lessons go, we’ll probably start doing these more in a webinar setting here in a couple of months, I’ve changed the website, we’ll be doing more webinar based, in a way for us to interact together, whether that’s a 10 person room, so that way you feel a little more safe and comfortable, that way it doesn’t feel overwhelming with 1000 people, but they’ll be recorder webinars, so that way if you have questions, you can ask specifically, we can evaluate, look at the stocks that you are looking at, and really hone in lessons.
Kind of like when you go to a gym or dance class or a martial arts class, you cover specific topics, so we’ll go ahead and do that, pretty much it’ll be like the let’s talk stocks sessions, but we’re going to go in depth into even more detail, into core lessons and about the stocks that you want to go in detail, we’ll look at growing your account, we’ll talk about a lot of different topics, but really in detail, and I’ll probably be multiple video lessons like this on a weekly basis.
I’m not sure exactly right now how many lessons I can do on a weekly basis in that sense, because it does take up a lot of my time, but let’s just say two lessons per week that maybe you have a Monday or a Tuesday lesson, and then you’ll have this Thursday freebie lesson and then you’ll also have this Saturday lesson, that we’ll go in detail and cover specifics about things like growing your trading account, setting up your account like how to properly trade, as far as getting tax breaks on your account, such as the 1256 contract rule from the RIS when trading options. Some people don’t know about that, but you can take a look at the 1256 contract rule, where you got the 60/40 tax rate there.
Just different things that really will help elevate your trading, and we can go into webinars and discuss things live in detail, so that’s probably going to happen after I release the options course, something that I’m working and planning on, because I want to get a little bit more connection going with you guys and really just hone in really make it work for you, really specific to you and your needs.
Those are some of the plans, right at this moment I can’t do it with the time that I have and the few things that I’m trying to wrap up, but we’ll get there, it takes time, takes a lot of work, and I do have people that are helping me with some things, but there’s just so much time that I have available.