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[Guru Dudette]

Bollinger Bands

"Trading Bands" are lines plotted in and around a price structure to form an envelope. It is the action of prices near the edges of the envelope that we are interested in. They are one of the most powerful concepts available to the technically based investor, but they do not, as is commonly believed, give absolute buy and sell signals based on price touching the bands. What they do is answer the perennial question of whether prices are high or low on a relative basis. Armed with this information, an intelligent investor can make buy and sell decisions by using indicators to confirm price action.

The figure above shows an example of this technique: Note in particular the use of different envelopes for cycles of differing lengths. Points A, B, and C deliniate potential bottoms for this market, wherein D and E represent the potential highs. The Bollinger Bands can often show maximum upside and downside movement in an individual stock or an indices. These maximum points are where savvy investors tend to look for buy or sell signals.

The next major development in the idea of trading bands came in the mid to late 1970s, as the concept of shifting a moving average up and down by a certain number of points or a fixed percentage to obtain an envelope around price gained popularity, an approach that is still employed by many.

[TTHQ Staff]

Bollinger Bands are similar to moving average envelopes. The difference between Bollinger Bands and envelopes is envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods. Bollinger Bands were created by John Bollinger and are usually displayed on top of security prices, but they can be displayed on an indicator. These comments refer to bands displayed on prices. As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper- and lower-band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices. Mr. Bollinger notes the following characteristics of Bollinger Bands. * Sharp price changes tend to occur after the bands tighten, as volatility lessens. * When prices move outside the bands, a continuation of the current trend is implied. * Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend. * A move that originates at one band tends to go all the way to the other band. This observation is useful when projecting price targets.