Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.

NEW TECHNIQUES

Signaling Change With Projection

Bands

Projection bands, a new method using trading bands, projects market data
forward along the data trend with the maxima and minima of the projections
defining the band. The method provides another means of signaling potential
changes for market direction relative to the trend.

by Mel Widner, Ph.D.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

B uy low and sell high" is the trader's tenet, and as a result, indicators that determine when prices may be low or
high are very popular. Trading bands, which are envelopes drawn about price histories, are one such set of
indicators designed to measure relative high and low prices. The envelopes are used to determine when prices are
high or low relative to the price history.

Trading bands evolved from simple envelope structures roughly sketched by hand to percentage boundaries about
moving averages to statistical methods - for example, Bollinger bands - that are adaptive to changing market
conditions. The latter method captures the average movement of the market by the moving average, and the
randomness and cyclic behavior by the variation around this average. When the price is several standard deviations
from the moving average, then it is at an extreme condition, a situation that often signals a reversal or sometimes a
breakout. When combined with confirming information, buy and sell signals can be generated.

Channel methods are an example of other methods with certain band characteristics. Channels are identified by
connecting peaks and bottoms with straight lines that can be projected as a boundary around a selected price history.
The rationale for this approach is that markets frequently move in a general direction with variations about this
general movement between short-term support and resistance levels.

Signals associated with touching channel boundaries or breaking out of the channel pattern are widely used and well
documented. A recent STOCKS & COMMODITIES article by Bob McCullough provides a quantitative means to
define channel boundaries using least-squares† fit analysis, noting that the channel boundaries often follow the same
slope as the fit. Channel methods require that the analyst must make some selections, such as start and end times. In
addition, long periods are often required to define the channel, and it is sometimes too late to take action once the
pattern is clear. (For more about trading bands, see sidebar, "Trading bands.")

Building on these techniques, the projection band method has features usually attributed to channel methods as well
as features attributed to trading bands. Projection bands attempt to develop an automated means of defining today's
trading bands by projecting previous data forward along a slope that reflects the trend in the data. The concept is
analogous to determining the present value of previous data viewed during a lookback period, assuming movement
along the observed trend. This implicitly reflects the average movement of the market as well as the variation about
this average movement. It could be thought of as an adaptive channel that is automatically constructed for a specified
lookback period that moves with the data history.

PROJECTION BANDS AND CLOSING DATA

An illustration of how projection is accomplished can be seen in Figure 1, where 14 days of daily closes for the OEX
are shown. The first step is to construct a least-squares fit to the data that is shown as the central line (A) through the
data in Figure 1. This is easily done using standard spreadsheet functions (the trend function in Excel).

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

FIGURE 1: OEX CLOSING PRICES. The closing price of the OEX on October 3 and October 6 are
projected forward to October 20 along trendlines B and C, which are parallel to the least-squares fit trendline A. The
projected prices are 442.98 and 430.93.

Next, determine the slope of the least-squares fit trendline, another function available in spreadsheets. The slope of
the line is the amount the line rises or falls each day. The notation SC i,n represents the slope of least-squares fit to
closing data. The subscript i refers to today's trading day, while the subscript n refers to the lookback period of
n trading days, in our case n = 14 days.

Then imagine that we pass lines with slope SC i,n through each of the data points and extend each line to reference
day i (today's date). These lines represent projections of the price values along the trend of the closing prices. The
value of the projection on day i (today) is the projected close C i,j and is defined for each lookback trading day
j as:

C i,j = C j + SC i,n (i - j )

Evaluation is straightforward and consists of adding the closing value on day j, Cj , to the change in value of the
trend. The change in the trend value is the slope of the trend multiplied by the number of days projected. For
example, in Figure 1, the slope of trendline A is 1.219 points. If we use the OEX closing price of 418.74 on October
6 for Cj as day 4 and project along the trendline (B) to October 20, which is the 14th trading day, then the value of
the projected price on October 20, Ci,j , according to the formula, is:

430.93 = 418.74 + 1.219(14-4)

Also in Figure 1, a second projection line (C) is shown. This line is based on the closing price of 427.13 on October
3. The value for the projected price on October 20 is:

442.98 = 427.13 + 1.219(14-1)

Figure 2 is Figure 1 with seven additional trading days presented. The 14-day lookback period used for analysis is
from October 31, the last day. Note that the new least-squares fit trendline (D) rises with a lower slope. The slope for
the new trendline is now 0.043. New projection lines (E and F) were drawn off the prices of October 24 and 28; the
projected prices based off the projection lines E and F for October 31 are 426.78 and 439.32. By restricting our use
to the projected prices that represent the extreme high and low price relative to the trend, we can create projection
bands.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

FIGURE 2: OEX CLOSING PRICES. An additional seven trading days has been added to the presentation in
Figure 1. Note the new least-squares fit trendline D has a lower slope. The new projected prices for October 31 are
426.78 and 439.32, based on the closing OEX prices of October 24 (E) and October 28 (F).

The projection bands will be the maximum and minimum projected price about today's close, Ci . The lower
projection band = PLC i = MIN (C i,j ), and the upper projection band = PUC i = MAX (C i,j ) for j = i -
n+ 1 to i . The upper and lower projection bands provide reference points that enable you to measure whether the
market is at the extreme high, low or somewhere in between relative to the extremes for the last 14 days. Figure 3
shows the closing price for the OEX along with the upper and lower projection band values for each day using n =
14 days. Obviously, periods other than 14 days can be chosen, although this is a good choice for several of the
examples to follow.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

FIGURE 3: PROJECTION BANDS AND OEX CLOSING PRICES. The projection bands are the daily
maximum and minimum projected prices based on the 14-day lookback period.

One feature of the projection band method worth noting is that the data always has the upper and lower bands as
boundaries and allows construction of a projection oscillator for closes, POC i , the features of which are similar to
the stochastic indicator. In fact, the projection oscillator might be thought of as being analogous to the stochastics
indicator with a trend correction. The POC i oscillator, expressed as a percentage, would be:

POC i = 100 (C i - PLC i ) / (PUC i - PLC i )

and a slow projection oscillator based on closes = POCS i,m is simply the m day exponential moving average
(EMA) of POC.

Figure 4 presents the closing price of the OEX, the lower and upper projection bands and the projection oscillator.
During this period in the OEX, the bands indicate potential boundaries to short-term moves, while short-term
reversals seem to correlate band contact with the data with some exceptions. The bands are also adaptive, expanding
and contracting with changing conditions, and the bands create a boundary around the data with no data overshoot.
The projection oscillator POC is combined with the slow projection oscillator POCS (green line) using a three-day
smoothing. This procedure is reasonably automatic and requires only selecting the lookback period and smoothing
period for the slow oscillator.

FIGURE 4: PROJECTION BANDS AND PROJECTION OSCILLATOR. The projection oscillator

measures the closing price relative to the upper and lower projection bands on a percentage basis. The crossover of
the projection oscillator and the slow projection oscillator at certain thresholds, such as below 20 or above 80, can
be used as part of short-term trading strategies.

While using only closing data has value and is sometimes dictated by data availability, the preferred method is to use
high, low and closing data, with the formulas and interpretation as follows.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

PROJECTION BANDS WITH HIGH/LOW/CLOSE

The objective of a trading band method is to establish a range of values to gauge a particular data value. Suppose we
wish to calculate bands for a particular reference trading day ( day I ) for a lookback period of n trading days. To
determine the upper band value, the highs for a specified lookback period are analyzed to determine the slope of the
least-squares fit to highs and will be noted as SH i,n from trading day i back n trading days.

In a similar fashion, the lower band value is denoted as SL i,n and represents the slope of the least-squares fit to
the lows. Usually, slopes SL and SH are not significantly different from one another or from the slope for the
least-squares fit to the closes for the same period.

The expression for the projected high H i,j is simply:

H i,j = H j + SH i,n (i - j )

The high on trading day j is H j , which is projected forward to the reference day i . Day j is a trading day within
the lookback period. The number of trading days projected is (i - j ).

Similarly, the expression for the projected low L i,j is:

L i,j = L j + SL i,n (i - j )

where L j = low on trading day j . The upper projection band PU i is given by the maximum of the projected
highs over the lookback period

PU i = MAX (H i,j ) from j = i - n + 1 to i

and the lower projection band PL i as the minimum of the projected lows over the lookback period

PL i = MIN (L i,j ) from j = i - n + 1to i

Figure 5 shows an example for the high, low and close data for the OEX for the same 14-day period as given in
Figure 1. The upper projection has the slope of the least-squares fit to the highs and the lower projection has the
slope of the least-squares fit to the lows. Also shown for comparison but not used is the least-squares fit to the
closes. These lines all have similar, yet different, slopes. The range between the upper and lower band values is also
greater than that shown in Figure 1. This range is used for the projection oscillator PO i , which gives the relative
percentage position of the close on day i = Ci compared with the upper and lower projection bands.

PO i = 100 (Ci - PL i )/(PU i - PL i )

A smoothed or slow projection oscillator POS i,m is also constructed by simply applying an m day exponential
moving average to the projection oscillator. This is a useful method for triggering signals by identifying crossings
between POS and PO. Typically, a value for m is three to five days.

POS i,m = EMA m (PO i )

An instructive example of projection bands and oscillators applied to high, low and close data can be seen in Figure
6. This shows a 100-day period from early 1994 for the OEX during which the market declined significantly over a
short period, experienced several bounces, and then recovered. Just prior to the decline in late March, the index
highs were near the upper band and, several days prior to the move down, began pulling away from the band.
Consistent with this action is a high value for the PO oscillator (greater than 80%). On March 21, 1994, the PO
oscillator dropped below 80% and crossed the slower POS, signaling a potential reversal to the downside.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

FIGURE 5: OEX HIGH LOW AND CLOSING PRICES. This chart show the least-squares fit trendline
(A) of the closing prices. Line B is the high price on October 3 projected forward using the slope of the least-squares
fit trendline of the highs, while line C is the low price on October 7 projected forward with the slope of the
least-squares fit trendline of the lows.

FIGURE 6: PROJECTION BANDS AND OEX DAILY PRICES. The upper and lower projection bands
are based on the high and low prices. The projection oscillator indicates where the closing price is relative to the
trading bands.

The index then crossed the band and moved to contact the lower band, where it remained as the market made a
significant move down. The price action actually pushed the lower band down, accelerating to a larger negative slope
for about six days, culminating with about a 30-point correction in the OEX. During this period, the projection
oscillator was at an extreme low value. On April 4, 1994, the index pulled up from the lower band, signaling a

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

possible end to the down move and a potential bounce.

Consistent with this was the crossing of the PO and POS and a move of PO from an extreme low value to one above
some threshold (say, 20%). Other similar situations with less amplitude can also be seen in Figure 6. This analysis
identifies potential signals such as band touching, a pullback from the band, oscillator extremes and crossings.
Confirming indicators should be employed before action is taken.

Another useful oscillator, the projection bandwidth that is denoted as PB i , is computed as the width compared with
the average of the bands expressed as a percentage:

PB i = 200 (PU i - PL i )/(PU i + PL i )

Figure 7 shows the same data as Figure 6, except the projection bandwidth indicator is used instead of the projection
oscillator. Here, low values indicate that the upper and lower projection bands are narrowing, while high values
indicate that the bands are widening. Low bandwidth values were a precursor to a trending market as in March and
the middle of June, while high values forewarned of the end of trends.

FIGURE 7: PROJECTION BANDWIDTH INDICATOR. The bandwidth indicator will reach low readings
during market consolidations that may forewarn of new trends. High readings may indicate the end of trends.

For readers interested in doing this work in their own spreadsheets, a compact formulation was devised for these
expressions using an Excel spreadsheet and is presented in sidebar "Projection bands and oscillators."

IN ADDITION
While projection bands can potentially be applied to many types of data and markets, their interpretation may differ,
depending on the character of the market (trading range versus trending). For example, for longer periods, the bond
market tends to operate in a trending mode. Figure 8 illustrates this, where daily closes for the 30-year Treasury
bond interest rate are plotted along with projection bands and oscillators based on closing information.

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

FIGURE 8: BOND MARKET TRENDING MODE. Here's where daily closes for the 30-year Treasury bond
interest rate are plotted along with projection bands and oscillators based on closing information.

For this situation, the data crosses between the projection bands from time to time, indicating temporary overbought
and oversold conditions.

A final observation: Projection bands give potential signals when price movement begins to deviate from the trend, a
condition that often precedes an actual upturn or downturn. For an advancing market, consider the case where the
price is rising but the price increase becomes less than the trend increase. The projection band would identify this
change, while other methods, such as stochastics, would not.

But that is not to say that there has been a valid signal; the projection band identifies a condition that the trader
should pay attention to. As a consequence, it is best to take into account additional criteria and confirmation such as
longer-term trends, price movement and underlying fundamental information.

Mel Widner, who holds a doctorate in engineering, is a research investigator and project manager. He has worked

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Stocks & Commodities V13 (275-281): Signaling Change with Projection Bands by Mel Widner, Ph.D

at two national laboratories and in the defense industry and has experience in analysis and simulation.

REFERENCES
Achelis, Steven B. [1995]. Technical Analysis from A to Z , Probus Publishing.

Bollinger, John [1992]. "Using Bollinger bands," Technical Analysis of STOCKS & COMMODITIES, Volume
10: February.

McCullough, Bob [1995]. "Statistically positioned trend channels," Technical Analysis of STOCKS &
COMMODITIES, Volume 13: February.

Murphy, John J. [1986]. Technical Analysis of the Futures Markets, New York Institute of Finance.

Pring, Martin J. [1991]. Technical Analysis Explained , 3d edition, McGraw-Hill.

Raff, Gilbert [1991]. "Trading the regression channel," Technical Analysis of STOCKS & COMMODITIES,
Volume 9: October.

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