A Lesson on Silver, Stability, and the Sigma Bands

May 28, 2011: 5:04 PM CST

Many investors were taken sharply by surprise initially by the stellar run-up in Silver prices, and then perhaps more so by the dramatic collapse in prices after the period of euphoria and instability.

But how do you define “instability” and “euphoria” objectively?

Let’s learn a lesson from Silver’s Sigma (Standard Deviation) Bands and see what they had to say about the stable rise that morphed into a multi-day unstable rise ahead of the violent collapse.

What we’re seeing is the Sigma Bands – or Standard Deviation Bands – for Silver futures in TradeStation (just like your typical Bollinger Bands, only showing SD levels 1 through 4 both above and below the 20 day average).

Each line represents a distance of one Standard Deviation above the mean.

Generally, price is contained within two SDs above or below the mean (average) which is the logic of Bollinger Bands.

However, expanding the Sigma Bands like this gives good insights when a market transitions objectively from tradable stability (inflecting between the 2 SD Bands) to high-risk instability (spiking and remaining outside the second standard deviation and even moving up into the third and fourth deviation).

We can see Silver behaved “normally” or at least “stably” from February to March as price bounced cleanly between the resistance of the Second Sigma Band and support of the First Sigma Band.

The S&P 500 showed a similar pattern during this time, as I’ve shown in prior blog updates.

After the March pullback, Silver continued this behavior into early April where “things started to go wrong.”

I’ve highlighted each time price spiked beyond the Second Sigma Band (typical Bollinger Band) and then returned lower immediately.

This behavior changed in mid to late April as price spiked sharply outside the Second Sigma Band and remained outside this level consistently – never pulling back the next day.

You can see in late April where Silver began resisting against the Third Sigma Band and then spiked finally into the Fourth Sigma (that’s four standard deviations above the 20 day moving average or mean) just ahead of its eventual crash-down into May.

The lesson is simple – trends can turn parabolic and rise higher than most people expect.  Eventually, as a market moves objectively from a stable/sustainable pattern into an unstable/unsustainable pattern, odds of a crash increase… if not become inevitable as the system/structure falls apart.

There were spike candles/reversal candles ahead of the initial crash which began officially May 2nd (your initial “serious warning” sign) and continued back to the $32 level on May 12th.

I know it was tempting both to call a top in silver each day during the parabolic move (those traders were right but early) or by the opposite token, to declare that “silver will rally forever.”

For most traders, it’s best to play predominantly in stable markets and manage risk appropriately – not getting caught up in greedily riding a euphoric ticking time-bomb… or calling the top in a euphoric market that can remain unstable longer than they expect.

Watching price relative to Sigma (or Bollinger) Bands helps assess the difference between:

Stable markets that are likely to continue moving in the same direction (resulting in slow, but steady potential profits),

and Unstable markets which could reverse violently any day (resulting in large potential profits that can evaporate into losses in a single day or bad week).  Think “Flash Crash” in stocks on May 6, 2010.

Corey Rosenbloom, CMT
Afraid to Trade.com

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7 Responses to “A Lesson on Silver, Stability, and the Sigma Bands”

  1. Irekesk Says:

    What is Corey going to say when silver hits 50,60, or 70. Charts are a tool to recognize what has happened it  doesnt fortell anything. Nobody can ready the future with certanty.

    Stock, commdities go  up and down to trade them is perilous. Long-term investors don't have the worries traders have. Silver or gold are good examples of what I am writing about.

  2. Corey Rosenbloom, CMT Says:

    So long as price returns to a normal, stable, uptrend we'll all be fine.

    It's these euphoric up then down moves that devastate both bull and bear traders.

    Stability and risk management is key whether as an investor or trader.

  3. nicholas thompson Says:

    I have to admit I was one of those greedy people leading a euphoric ticking time-bomb.  In hindsight it  was so crazy going over night with a basket of $100,000 silver  at $50.   But you know what I made it out, and I made it out way stronger.  I learnt a very valuable lesson that has helped my trading 100 fold since, how to trade vs bubble out!  I also got hit bad by the flash crash, I had sold short $50,000 in puts, and the market imploded.  Everything I trade collapses, and I told everyone before the silver crash I was going to single handily take down silver just by buying in.  Then I was right!   I began trading in 1999, that was my first bubble.   I made $10,000 in an hour one day, and the next day on from then on the market pulled a silver!  Now were in 2011 and this time it is going to be different.  Bet you wonder what I am trading no!!

  4. Terlyn12001 Says:

    Really interesting, Corey.

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