Trading with Acceleration Bands

05/03/2012 2:05 pm EST

Focus: TOOLS

Price Headley

Founder and Chief Analyst,

Acceleration bands can be used to spot powerful moves where big gains can be captured in small time periods, explains Price Headley, who relies heavily on this indicator in his trading.

My guest today is Price Headley and we’re talking about acceleration bands and how he uses those to find good opportunities. So Price, first of all, what is an acceleration band?

Basically, our focus is that when you’re a trader, you want the maximum move in the minimum amount of time, especially if you’re an options trader, which is our particular focus, although we do a lot with stocks, ETFs, and futures as well.

It’s all about finding those sweet spots where something makes that unusual move. There are a lot of times things are bumping between support and resistance; our experience is that’s not where the bigger opportunity lies. The bigger opportunity is really when things break outside of that support and resistance.

Most people can relate to that, just when things start to break to a new high or a new low, but we’re rather looking at what that trend has been, and when it starts to go more parabolic, when it starts to either accelerate to the upside or starts to fall off a cliff, that’s where you can make a lot in a relatively short period of time.

You have to know how to manage that risk, but our acceleration bands indicator really helps people to see that. It’s all based on the trend and the stock’s volatility, so just factoring in the more volatile it is, the wider those bands are going to be, and also, if it’s been trending, that band is trending up.

So to get a real acceleration, it’s got to move even faster than whatever that recent rate of growth has been, so that’s something that helps us to find that parabolic bubble, if you will, when it starts to really accelerate, and it also tells us when the bubble pops, so it gets you out.

You’re never going to get out at exactly the top if you truly follow the indicator, but it’s going to tell you when it’s time to walk away and move to the next opportunity.

All right, so talk about those breakouts of support and resistance. The question I hear a lot of people ask is “How do I know at what point above that to buy, or what point below that to sell?” because it could come back up and then pop right back in again; you’re never quite sure.

You know, that’s exactly right. There’s a big difference between a true breakout and a lot of the fakeouts. So many traders are getting whipsawed because they think they see that move through that resistance and starting to break out upside, but the reality is that one bar doesn’t make a trend.

We look for two straight bars outside of our acceleration bands, so you’ll see a lot of times where you’ll try that one time and it’ll fake and shoot right back down, sometimes violently, so you really have to make sure when it gets in one of those steady trends, like, say, Apple (AAPL) has been in recently, it was really just a classic acceleration up over about a six- to seven-day time span.

To make that kind of a move on that big of a stock, it shows you kind of that pylon effect; it’s like everybody wants in.

There’s a tendency a lot of people have to think they have to be a contrarian on these things, and I’ve learned once they start accelerating, you just need to get on for the ride, and then basically you have to just have a good trailing stop.

We’ve got a couple of rules that we use for basically a moving average that we trail with, as well as the bands themselves, so whichever one gets violated first tells us to start backing off and moving on or waiting for that next opportunity.

Let’s talk real briefly about that trailing stop. Do you place it just below that acceleration band, or how do you decide?

We’ve tested a lot of different moving averages and what we find is the exponential moving average works a lot more effectively because it’s faster than a classic simple moving average.

Quickly, that just means a simple moving average is an even average of all the recent closes. The exponential puts more weight on the latest closes than the older data, so we’ll typically test and use a very short-term exponential moving average to keep with that really powerful uptrend or downtrend, but when it does turn significantly enough, it will have caught up.

For some of the best trends, the exponential will actually be outside of the acceleration bands on the upside catching up faster because it’s just moving so dramatically parabolic, and so that’s going to get us out first in that kind of a move versus some of the steady acceleration trends where they just keep on chugging along outside of those bands. The bands will usually get us out before even the exponential moving average.

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