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Indian technology ADR set for Bollinger band breakout

May 28, 2012

28 May

My Bollinger band contraction and breakout method states that bands must be at their most contracted in three years. It gives the entry criteria but it does not define the period of the bands.

By default, I use a 40 week exponential moving average and two standard deviations on the bands. Scan results can vary with these parameters significantly, so which parameters are correct?

There is no single correct answer, instead, I check for:

  • The moving average has done a reasonable job of defining the trend and the turns over recent years
  • Previous band contractions have done a reasonable job of leading to breakouts

Having looked for band contractions on pairs involving an Indian technology outsourcing stock Patni Computer (PTI), I found from many more positive scan results on 25 week bands than on 40 week bands.

Patni Computer (PTI) v NASDAQ 100 Trust (QQQ)

Ptiqqq_weekly_280512

  • The 25 week moving average has defined the trend well, there have been no false turns of the average
  • The band contraction in 2007 led to a reversal, although not without a significant pullback into the pattern
  • The contraction in 2009 led to a breakout (usually I look for continuation rather than reversal)
  • The contraction in 2011 was not particularly tight, so although it didn’t follow through, I would place less weight on this
  • Now, the bands are their tightest ever and with the moving average rising, I am looking for a break above the upper band as an entry signal
  • By comparison, the 40 week bands are less contracted at key turning points, although the 40 week moving average is still fits reasonably

Conclusion: Buy Patni Computer (PTI) vs. NASDAQ 100 Trust (QQQ) on an end of week close above the 25 period bands, with an expansion of the band width.

Patni as a RSI divergence example

At the 2011 low, there was a weekly RSI divergence. The first divergence did not produce a move above the intervening RSI peak, but the second one did.

Daily chart

Ptiqqq_daily_280512

  • The daily RSI at the low was above 30 (meeting my criteria)
  • Sometimes you don’t always get a convenient entry point, like a pullback and a higher high
  • If the ratio breaks the upper band, that will likely entail a break of resistance since late February

 

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