The Concept of Volatility Bands

Volatility bands are dynamic lines that shift with market prices over time, aiming to encompass them. The most recognized volatility bands are Bollinger Bands. Typically, they utilize a smoothing technique on market data followed by a volatility measure to assess normality.

In contrast, Fibonacci volatility bands adopt a similar concept but integrate the famous Fibonacci sequence, where each number is the sum of the two preceding ones. The Fibonacci ratios derived from this sequence, particularly the well-known ratio of 1.618, are utilized in these calculations.

For those interested in the details surrounding the Fibonacci sequence and Bollinger Bands, previous articles provide valuable insights. For now, let's focus on coding Fibonacci volatility bands in Pine Script, the programming language used in TradingView, a leading charting platform.

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Creating Fibonacci Volatility Bands

The objective here is to construct and display Fibonacci volatility bands on TradingView. First, create a free account to access the charts. Once logged in, locate the Chart button on the homepage and select any asset for which you wish to calculate the indicator. Next, find the Pine Editor at the bottom of the screen and prepare to start coding.

The steps to create this indicator include:

1. Compute a 20-period average true range (ATR) for the market price.
2. Calculate a 20-period moving average of the highs.
3. Calculate a 20-period moving average of the lows.
4. To determine the first resistance, multiply the ATR by 1.618 and add it to the first moving average.
5. For the second resistance, multiply the ATR by 2.618 and add it to the first moving average.
6. For the first support, subtract 1.618 times the ATR from the second moving average.
7. For the second support, subtract 2.618 times the ATR from the second moving average.
8. Finally, calculate a 20-period moving average of the close price, which will serve as the middle line.

The indicator should resemble the chart below.

Example of Fibonacci Volatility Bands

The bands can be utilized similarly to Bollinger Bands. Now, let’s look at how to code this in Pine Script.

First, specify the version of Pine Script, which is version 5, noting the slight changes from the previous version.

//@version = 5

Next, define the indicator's name using the following syntax:

indicator("Fibonacci Volatility Bands", overlay = true)

Now, calculate the ATR and the moving averages:

atr = ta.atr(lookback)

sma_high = ta.sma(high, lookback)

sma_low = ta.sma(low, lookback)

Next, apply the support and resistance line calculations:

first_resistance = sma_high + (atr * 1.618)

second_resistance = sma_high + (atr * 2.618)

sma_middle = ta.sma(close, lookback)

first_support = sma_low - (atr * 1.618)

second_support = sma_low - (atr * 2.618)

Finally, use the following syntax to plot the indicator:

fr = plot(first_resistance, color = color.black)

sr = plot(second_resistance, color = color.black)

fill(fr, sr, color = color.new(color.black, 90))

fs = plot(first_support, color = color.black)

ss = plot(second_support, color = color.black)

fill(fs, ss, color = color.new(color.black, 90))

plot(sma_middle)

Example of Fibonacci Volatility Bands

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Summary

In conclusion, my aim is to contribute to the realm of objective technical analysis by promoting transparent techniques and strategies that require thorough back-testing before implementation. This approach seeks to improve the perception of technical analysis, moving it away from the notion of being subjective and lacking scientific basis.

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Whenever you encounter a trading technique or strategy, I recommend following these steps:

1. Maintain a critical mindset and eliminate emotional biases.
2. Back-test it using real-life simulations and conditions.
3. If potential is found, optimize and conduct a forward test.
4. Always factor in transaction costs and slippage in your tests.
5. Incorporate risk management and position sizing into your evaluations.

Lastly, even after confirming the above, remain vigilant and monitor your strategy, as market dynamics can shift, rendering previously profitable strategies unviable.