Moving to the second of our volatility indicators, namely Starc bands, whilst these appear similar when applied to the chart, their calculation is very different to that of Bollinger bands. Bollinger bands use standard deviation, whilst Starc bands use average true range. This results in some interesting differences when applied to the same chart.
The calculation for the Starc bands themselves is a little more complicated, but as with Bollinger bands this is all done automatically within the indicator.
In simple terms, both the upper and lower band step back six periods from the simple moving average period, which is generally either 14 or 20. For simplicity and comparison with Bollinger bands, I have set this to 20 in the following examples. And here we have an example using the Emini ES futures contract on a daily chart.At first glance this looks very similar to Bollinger bands. We have three lines, one upper band, one lower band and the 20 period simple moving average in the centre.
However, look more closely at Fig 7.20 – where are the squeeze zones? These appear to have been smoothed out in the calculation, and to confirm this, take a look at Fig 7.21 which is the same chart, but this time replaced with Bollinger bands.As you can see, the distinct squeeze zones of the Bollinger bands are now back, with that descriptive rise and fall as the volatility ebbs and flows. The Starc bands, on the other hand, are smoother and lack these distinctive variations, from which several questions follow.
Such as, why, which indicator is the right one to use, and is there a place for both?And to answer the last question first, I believe there is a place for both. Whilst both indicators are measuring risk, the information they display is very different. One cannot exist without the other, and this is how to consider these two indicators. Bollinger bands are more suited to describing volatility, whilst Starc bands are more suited to describing risk.
But what does this mean?If we start with standard deviation, the basis for Bollinger bands, standard deviation is a measure of how disperse prices are from the mean. You can think of this like plucking a guitar string – first it is pulled, then released, and the string subsequently vibrates several times before returning to rest in the same position it started. Starc bands however, take a different approach.
In using average true range, they are considering the range rather than the dispersal of price action. You can think of this in terms of target shooting and the analysis of the target hits. In one case you would be considering the grouping, the spread if you like, and whether the target hits were closely grouped or widely spread, whilst the second approach would be to consider the range of spread, the extremes if you like.
A simple analogy perhaps, but this in essence is the difference between an approach to volatility using standard deviation and one using range. Bollinger bands use the closing price for calculation, whereas Starc bands use the average of the range.There is no right or wrong way to apply these indicators, just the best way for you. Moreover, all indicators except volume and price are lagged in some way.
Indicators are there to help us fill in some of the blanks of trading, of which volatility is one of the most difficult to pin down. Bollinger bands and Starc bands are not entry or exit indicators, but are there to provide us with a better understand of volatility, and to describe it for us simply, clearly and in a meaningful way.But which do we use and how? And here I can only try to offer you some guidance.
Starc bands were originally developed for trading commodities using slower time frame charts.Volatility and risk go hand in hand and this is perhaps the best way to think of these two indicators. Starc bands are essentially attempting to define the risk associated with the market volatility. In other words, the bands themselves are more important here, as they are trying to define risk extremes, overbought or over sold and as such, potential points at which the market may reverse.
Some traders attempt to use Bollinger bands in this way, but in my opinion this is flawed given the underlying mathematics of the indicator. Starc bands on the other hand are trying to signal just that, with the two outer bands defining risk.As price reaches these bands, the risk of a reversal is increased. In addition, and given the underlying calculations, Starc bands take a more ‘considered’ view of price action. A longer term view, a more ‘in depth’ view of market volatility.