BOLLINGER

Stocks & Commodities V. 20:5 (56-65): Interview: John Bollinger Of Bollinger Bands Fame by Jayanthi Gopalakrishnan INTERVIEW

Objective Trading

John Bollinger Of Bollinger Bands Fame Unlike many technicians who start out with degrees in business, veteran analyst John Bollinger, the president and founder of Bollinger Capital Management, started out with a decidedly unmarket-like bent. He graduated from the School of Visual Arts majoring in cinematography, and only afterward started studying the market. Since then, though, he’s become one of the best-known market analysts in the field, with the now-classic Bollinger Bands technique to his credit (which has been integrated into most analytical software currently in use), as well as a slew of other techniques and methods. He is a Chartered Financial Analyst (CFA) and Chartered Market Technician (CMT), is an active member of the financial community, and is a frequent lecturer at national and international investment seminars. Not only that, Bollinger’s Capital Growth Letter provides investment advice for the average investor employing a technically driven asset allocation approach. His Group Power provides industry group analysis using a group

Did this approach work well? Actually, it had a number of problems, the biggest of which was the selection of the bandwidth. We couldn’t decide if they should be 3.5%, 4%, 4.5%, or 5%. Empirically, what we would do was try to fit them so they contained most of the data over the past year or so, and those would be the bands we would use. But doing it that way meant it was a trial-and-error process, and back in those days, we didn’t have the computer power that we have today. So how did you end up doing it? A lot of it was done by hand or on very slow mainframe computer systems, where you would submit a job and get the answer back hours later. It just wasn’t a

CARL GREEN

H

ow were Bollinger Bands created? I created the bands in the very early 1980s. At the time, we used fixed-width bands for market timing. We took an average, say of the Dow Jones Industrial Average (DJIA), and we would shift that average up and down by some percentage, 4% or 5%, and use that as a measure of price action. When prices rallied and tagged the upper band, we would check on various indicators to see whether they confirmed that strength. If they did, we took it as a confirmation signal, and if they didn’t, we took it as a nonconfirmation or a sell. Likewise on the downside, if prices made an excursion to the lower band, we would check indicators — most of which were based on either volume or breadth — and see whether the negativity was confirmed. If it wasn’t, then we had a buy signal on our hands.

structure. Bollinger developed a website called EquityTrader, which provides investors with a quick and easy method of evaluating the past performance and potential appreciation of equities. EquityTrader evaluates its universe of equities using a fuzzy logic engine that considers both technical and fundamental factors, a combination he calls rational analysis. BollingerOnBollingerBands.com is Bollinger’s most recent website. The site provides access to the trading systems that are introduced in his latest book, as well as daily lists of the stocks that qualify for the three methods, mentioned therein. There is also a charting area that includes a variety of indicators and candlestick charts. After purchasing his first microcomputer in 1977, Bollinger became involved in the seminal stages of computer-driven market analysis. Today, he continues to write some of his own software. S TOCKS & C OMMODITIES Editor Jayanthi Gopalakrishnan spoke with Bollinger via telephone on February 22, 2002.

My advice to the investor? Be true to yourself, because that’s more important than anything else.

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 20:5 (56-65): Interview: John Bollinger Of Bollinger Bands Fame by Jayanthi Gopalakrishnan

workable solution. Another problem that came up was that once the correct bandwidth had been identified, it would change over time. There might be one year where 3.5% or 4% bands are the appropriate bandwidth, whereas in the following year, 5% or 6% might be. It was not only a terrible problem to solve each time, but you also had to keep going back and revisiting the problem. What did you do to solve it? I looked for some methodology that would allow the bands to be set automatically. At the time, I was very interested in the options business — options, warrants, convertibles, rights, and so on. Because of that I thought a tremendous amount about volatility. In those days volatility was only calculated in a static manner, which means you would have to go back to a stock and calculate the standard deviation for the past six months or the past year, and only then would you use that number going forward. We did it this way mainly because it was too difficult analytically to do it any other way. Fortunately, I had one of the first microcomputers — an old CP/M operating system — and I actually had a spreadsheet called SuperCalc. This allowed the calculation and recalculation of items on a daily basis. So my real contribution was to change the calculation of volatility from a static calculation to a dynamic one, and couple that with a moving average to provide a set of trading bands. Since the 1980s, there have been many changes in terms of products in the markets. Have you had to make any changes or adaptations to the Bollinger Bands to accommodate them? No, that’s the wonderful thing about them. They are self-adaptive, because they are driven by volatility. As the

characteristics of the market change, the characteristics of the bands change. I haven’t found any need to change anything over the years. There’s actually been quite a bit of academic study in this area, and one of the conclusions that the academics come up with is that price is not particularly cyclical, nor is it forecastable using cycles. But volatility is both cyclical and forecastable using cycles. So if you think about it, what we really end up trading is not price, but volatility. By using volatility to derive the bands, you are creating a system that is in tune with the mechanisms that are driving the price structure. The bands exist really for one purpose, and that is to provide the answer to the question: “Are prices high or low on a relative basis?” By definition, when prices are at the upper band, they are high, and they’re low at the lower band. Those definitions have been robust because they’re driven by volatility. The bands themselves are a moving average, plus/minus two times the standard deviation of the same data that was used for the moving average. Standard deviation, of course, is the standard measurement for volatility. And the reflection of that volatility is the “squeeze,” correct? There are two indicators that are derived from Bollinger Bands. The first one is %b, and that tells us where we are within the band — at 1.0, we’re at the upper band, and at zero, we’re at the lower band. At 0.5, we’re dead in the middle. The second indicator is bandwidth. It is the upper band, minus the lower band, divided by the middle band. So it’s a direct function of the standard deviation of the series. As such, when you plot bandwidth, you see the cyclicity of volatility in a dramatic manner. Nowhere is this more evident than in the bond market, where there is an astonishingly clear 19-day volatility cycle. The problem is that in most applications — most stocks, most futures, or most anything you’re trading — volatility is not cyclical in the sense that people have come to expect. People expect a cycle to be regular in terms of time — you know, for a trough to come Copyright (c) Technical Analysis Inc.

every 20 days or every 60 days. But volatility doesn’t usually work that way.

H

ow does it, then? What’s interesting about volatility is that very low volatility is a forecast for very high volatility — and that is the squeeze. The opposite is true also: very high volatility is a forecast for very low volatility. So what we like to do, rather than try to analyze a regular time cycle in bandwidth, is identify extremes and then take the opposite side of the trade whenever an extreme is identified. For instance, if you have a huge rally that’s driving volatility dramatically higher and therefore driving the bandwidth dramatically higher, we’ll sell that rally when the bandwidth rolls over. Similar to an oscillator, perhaps? It is similar, but if you will, it’s a bimodal oscillator, because we treat high volatility differently than we treat low volatility. However, it is in fact an oscillator that rocks back and forth between high and low values, but we do different types of things at low values than at high values. Since you’re looking at these extremes, it seems to me you’re basically using them to tell you when a trend is going to reverse. That’s right, and you’ll see that peaks in bandwidth almost always mark the transition from a trend either to a nontrending environment or to a trend in the opposite direction. Sometimes it means that the current trend is over, and we’re going sideways for a while. Sometimes you get a reversal, but you have to rely on other indicators to tell you that. What’s important is that when you’ve had a big expansion of volatility, and that expansion of volatility ends, at best you would expect a consolidation to begin, and at worst you’d actually get a reversal. But you can also use Bollinger Bands to identify continuations in trend, not just the points where the trend is going to end, by using something called

Stocks & Commodities V. 20:5 (56-65): Interview: John Bollinger Of Bollinger Bands Fame by Jayanthi Gopalakrishnan

“walking the band”†. How do we go about interpreting this? Often, the very first stage of a walk is when prices go beyond the bands, either up the upper band or down the lower band. The walk will usually be announced by a rally or decline that punches outside of the band. What you’ll get, if it’s going to be a walk, is a pullback, and then you’ll get another rally that will carry you to the upper band, and then you’ll get another little pullback and another rally. What you’ll see during this period — and it’s very interesting — is that the bandwidth will remain more or less constant. So the bands actually form a channel, and price will ascend in the upper portion of the channel, or decline in the lower portion of the channel. So when you see them — and they’re not all that common — you’ll recognize them, because they’re very beautiful and very well defined. Because of the tight structure of the formation, you can immediately identify when you’re facing a transition, and when that phase of market activity is going to end. Can you use them as effectively during sideways movements? In June 1998 we transitioned from a bull market environment that had prevailed for 16 years to a sideways environment that will prevail, I would guess, for the rest of this decade. At least, that’s my current analysis for the stock market. So, we’re now in a different type of environment than most investors are familiar with. Most investors are familiar with a market that has a long-term positive bias, and they use that positive bias to bail them out of their mistakes. They use the long-term uptrends in stocks to compensate for less than optimal stockpicking. In the environment we’re in now, they won’t have that comfort. In this environment, it’s going to be much easier to buy tags of lower bands and sell tags of the upper bands. I think we’ll get less in the way of prolonged trends and more in the way of reversal opportunities at the bands.

reversals. I know you use volume a lot, and I know you use momentum indicators a lot. But what is your experience using indicators such as the RSI? The relative strength index (RSI) is a very useful indicator. I prefer the version that was published in your magazine some years ago. Which one was that? Gene Quong and Avram Soudack published a version of RSI called MFI, the money flow index, which is simply a volume-weighted RSI. That’s the version I prefer. I’m firmly of the belief that there’s a great deal of information in volume, and most investors ignore it. I try to use volume indicators whenever I can, and that includes adaptations of the traditional indicators such as RSI or the moving average convergence/ divergence (M ACD ). There’s an adaptation of the MACD that uses volume also, the volume-weighted M ACD (VWMACD), created by Buff Dormeier. He’s a creative analyst, and I’ve seen several projects he has worked on. When he showed me the VWMACD, I was hooked — it’s such a simple idea, but nobody had it before! I remember that from an article we ran by Dormeier last year. So it seems like you prefer to use volume indicators or combine indicators with volume. Yes, I do prefer volume indicators, and I especially like these hybrid indicators, where you take a traditional trend indicator or a traditional momentum indicator, and couple it with volume. The reason for this is that in most analyses, people spend a tremendous amount of analytical effort on the close — trying to define rising trends, forward trends, or sideways movements. Less weight is

placed on the high and low, and even less weight is placed on the open, and even less weight than that is placed on the volume. For most analysis, volume is an underutilized source of noncorrelated information that investors would do well to consider. I remember you stating you believed that volume precedes price. That’s not my statement. That’s a very, very old statement. I wish I were the one who said that! That’s the basic idea behind all volume indicators, the concept that volume precedes price, and that’s from before I was born. That’s out of the 1920s and 1930s. It may have been someone like Richard Wyckoff who came up with it. I wish that saying were in my portfolio! You also frequently use something called “intraday intensity” and the accumulation/distribution line. What exactly is intraday intensity? Intraday intensity is a volume indicator that derives its information from where we close in the day’s range. The thought process behind it is that as we draw toward the end of the day, traders feel it’s imperative to complete their positions, to go home having finished everything. If you examine the close in relation to the day’s trading range, you can see where the preponderance of the day’s order flow was driving. If prices are consistently closing on the lows, it’s a negative phenomenon. If they’re closing near the highs, it’s a positive one. Intraday intensity is based on that concept. It was written by a fellow by the name of David Bostian. The accumulation/ distribution indicator, written by Larry Williams, takes a similar approach but instead of looking at where we close within the day’s range, it looks at the relationship of the open and close. How’s it work? If prices consistently close higher than they opened, it’s a positive indication. If, on the other hand, they consistently close lower than they opened, it’s a negative indication. This is very closely related to the candlestick

You were saying earlier that you also use indicators to confirm trends and Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 20:5 (56-65): Interview: John Bollinger Of Bollinger Bands Fame by Jayanthi Gopalakrishnan

charts. So when you consistently see negative bodies or black bodies, then accumulation/distribution will be negative. When you consistently have white bodies or positive bodies, accumulation/distribution will be positive. I’m very interested in the idea of first principles, and I only tend to use an indicator when I understand its first principles. For instance, intraday intensity looks at the order flow generated by large traders and professionals. Accumulation/distribution looks at the balance of trading during the day. It ignores where prices closed the previous day and only looks to see if there was enough momentum and buying purpose in the market to carry prices higher than where they opened. So it looks at the strength that actually develops during the trading day. Intraday intensity and accumulation/ distribution are two different ways of parsing a day’s price activity to relate it to the emotions that drive traders. And that’s the bottom line of technical analysis. If people were to think about it, they would realize that market technicians are nothing more or less than psychologists. What they’re doing is assessing the underlying psychology. They’re buying when that psychology is positive, and selling when that psychology is negative. They’re also looking for transitions from negative psychology to positive psychology, and vice versa. That’s the real calling. It’s one of the reasons I worry about people who take too mathematical an approach to the markets. I fear they are missing a very important dimension of the market, the psychological underpinnings. Some systems people get too cranked up into the mechanics of the price structure, and they forget that human beings are creating the structure. We need to understand the mechanics of the price structure as a function of greed and fear.

and take out the three best tools, and then if you were to open up the fundamentalists’ toolbox and take out the two or three best tools and then combine them all, that would be rational analysis. It’s simply using the best tools available, without regard to the labels on the toolboxes. What are the best tools in the fundamental arena? On the fundamental side, earnings growth is a very important part of the puzzle; the price that we pay for earnings growth, which some people call the PEG ratio, is also important. Yield is also important, as well as the overall valuation, in that it can break the equities universe into useful parts. For example, the B ARRA indexes use valuation measures to break the big indexes into value and growth components — a very useful concept. Market capitalization is very important also. Do you use any mathematical systems at all, or do you use a subjective type of analysis? We use mathematical systems extensively, but we always anchor them firmly in the underlying psychology. We have nothing against systems trading. Those approaches are very useful, especially for the casual investor who doesn’t have a great deal of time to devote to the process. I remember early on in my career when I was first learning technical analysis from a professional trader, I was sorting through to try to find some system or approach to use. He looked at me and said: “Pick a system. Any system, it doesn’t matter. Just use it.” In investing, there are many systems that can produce good returns in a portfolio. The problem lies in having

Is that what you refer to as rational analysis? Actually, rational analysis takes that process one step further and suggests that we include some fundamental tools along with our technical tools. If you were to open up the technicians’ toolbox

the discipline to use them and stick to them. Look at the process of selecting a portfolio manager. Most people find a list of the best-performing portfolio managers, pick one of the top two or three people on that list, and then give them some money. That’s exactly the opposite of what should be done.

W

hat should people do? What they should do is find a portfolio manager who is substantially underperforming and whose approach is vastly out of favor with the market. Then they should check to see that they haven’t jumped overboard, are still sticking with their system, following their discipline and their approach. Only then should you give them your money. This is because these types of approaches are cyclical; they come in and out of favor. So the odds of picking an extremely well-performing money manager and having that performance continue are slim, whereas the odds of picking a money manager whose style is out of favor at the moment and having that style come back into favor are much higher. I’m not suggesting you pick something that is truly broken. For instance, after a long period of high performance by growth managers, it’s time to buy value managers. And after a long period of performance by value managers, it’s time to buy growth managers. But people do exactly the opposite. They wait for a long string of performance, and then they buy into that string of performance. There’s a famous book, Winning The Loser’s Game, which discusses this process. And David Dreman has written extensively about the process of selecting managers and come to similar conclusions. I went to your website, www.Equity Trader.com, and noticed something called power shift† that you use to measure the strength of the movement to determine when the trend is going to change its direction. How do you measure that strength?

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 20:5 (56-65): Interview: John Bollinger Of Bollinger Bands Fame by Jayanthi Gopalakrishnan

Power shifts are a two-step process. First, we measure how overbought or oversold a security has become. We require not only that a security become oversold or overbought, but also that the oversold or overbought level is the greatest level that has been achieved in the past year. Then we look for enough strength to change the trend. For that purpose we use a traditional momentum indicator. So it’s really a two-step process: for a buy signal, the stock has to become severely oversold, not just on an absolute basis, but also on a relative basis. Then it has to generate enough momentum to break the back of the trend. What would you suggest to someone who wants to become an expert in technical analysis? How might they gain a solid understanding of the markets? I have the perfect answer for that! I suggest they go down to their community college and take a few courses. Take an introduction to psychology course, and one in mass psychology. Then take a course in statistics, but not one given by the math department; take one given by the psychology department. What that class is going to focus on is how to use

statistics, instead of how to calculate them. They’re not going to turn you into a mathematician, but they’re going to teach you about numbers and what numbers mean, and what they don’t mean. That’s a very important piece of the puzzle. By doing this you come out with some knowledge about the basic principles that drive the market, and an understanding of what the numbers mean and how to use them, and especially how not to get caught in some of the typical traps. That’s an interesting approach. We make a strong effort here to, as they say, “think outside the box.” If I had advice to give to the investor, it’s be true to yourself, because that’s more important than anything else. Only that way can you be successful in investing. You can’t go and buy somebody else’s system and use it, because their system won’t match your psychology. You have to develop your own approach, and you have to match your risk/reward criteria. Only by doing that can you achieve success in the market. That’s great. Thank you for taking the time to speak with me, John.

Copyright (c) Technical Analysis Inc.

SUGGESTED READING Bollinger, John A. [2001]. Bollinger On Bollinger Bands, McGraw-Hill. Dormeier, Buff [2001]. “Buff Up Your Moving Averages,” Technical Analysis of STOCKS & COMMODITIES, Volume 19: February. Dreman, David N. [1998]. Contrarian Investment Strategies: The Next Generation, Simon & Schuster. Ellis, Charles D. [1998]. Winning The Loser’s Game: Timeless Strategies For Successful Investing, McGrawHill. Quong, Gene, and Avrum Soudack [1989]. “Volume-Weighted R SI: Money Flow,” Technical Analysis of STOCKS & COMMODITIES, Volume 7: March. www.BollingerOnBollingerBands.com †See Traders’ Glossary for definition

S&C

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle INTERVIEW

John Bollinger Of Bollinger Capital Management John Bollinger, C.F.A., C.M.T., former market analyst for CNBC/FNN, president and founder of Bollinger Capital Management, author of the “Capital Growth Letter” — a market letter for the average investor employing a technically driven asset allocation approach — began as a cameraman for the movies before he switched to the quickly expanding world of computerized investing. From there, he went on to form investment techniques for which he gained renown, including the Bollinger Bands, in which moving standard deviations are used to plot trading bands around a moving average. STOCKS & COMMODITIES Editor Thom Hartle spoke with Bollinger on April 21, 1993, covering topics ranging from those trading bands to his philosophies on going long and going short.

H

ow did you get started in the business? Originally, I was a cameraman in the motion picture business. In the late 1970s, I purchased one of the early microcomputers and started thinking about how the early computer technology could be married with investment technology, such as it was in those days. The technology was rapidly evolving at the time. Over the next few years, I slowly switched my focus from the film business to the investment business. What an unusual beginning! And out of that beginning came a logical theme that continues to dominate. When you look at the capacity of a computer, even the early microcomputers, you see how they could help in the investment process. The calculation of even the simplest indicator was done by hand then, and it was a time-consuming task; but it was easy to write a basic program that could calculate the indicators that we used at the time. So by using this little microcomputer — pre-IBM PC, I might add — I was really able to make a lot of

Essentially, I look at stocks from a fundamental point of view and make a buy list and a sell list. I use technical analysis to execute buys and sells using those lists. Sometimes a stock can be on the buy list and I’ll never buy it because the technicals are never right. There’s something genuinely wrong with the company that is not evident from fundamental analysis. In cases like that, the situation will just continue to deteriorate and ultimately the company will disappear, merge, be bought out or go bankrupt. —John Bollinger

progress and do some things that weren’t being done widely because computationally they were too complex. It allowed me to get a leg up on the rest of the market participants.

How do you combine them? Essentially, I look at stocks from a fundamental point of view and make a buy list and a sell list. I use technical analysis to execute buys and sells using those lists. Sometimes a stock can be on the buy list and I’ll never buy it because the technicals are never right. There’s something genuinely wrong with the company that is not evident from fundamental analysis. In cases like that, the situation will just continue to deteriorate and ultimately the company will disappear, merge, be bought out or go bankrupt.

Did you look for the Holy Grail of investment, like everyone else? I started off as probably everyone does, as a fundamentalist, and then became very frustrated with that approach. I would find time and time again that the fundamental stock facts would indicate you should own this stock or that stock and then that stock would go down, or the fundamentals I’m very interested in price-volume would say that you should work. I find the theory of volume sell the stock and when you preceding price to be quite useful. did, the stock would go up!

I’m a big fan of Joe Granville’s onSo what did you do? balance volume and Marc Chaikin’s I tried to add some value money flow (see Traders’ Tips). with technical analysis, and over the years I’ve developed an approach that marries the two I would hope that’s a rare event. What disciplines. The buzzword that I use is would look good? rational analysis, which is a combination A stock that, after having been on of technical and fundamental analysis. my buy list for a while, suddenly starts to have money flow in. The on-balance volCopyright (c) Technical Analysis Inc.

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

ume measures start improving and the relative strength measures turn positive. The stock will form big saucer bottoms and start screaming out to be bought. Then it’s fairly easy to apply technical discipline and execute the buy signal. At that point you have the best of both worlds. You have a company that you think is going to do well from a fundamental point of view and you have the timing of that investment correct. What are your guidelines to time the acquisition of a stock with favorable fundamentals? I’m very interested in price-volume work. I find the theory of volume preceding price to be quite useful. I’m a big fan of Joe Granville’s on-balance volume and a big fan of Marc Chaikin’s money flow (see Traders’ Tips). When combined, these two concepts can tell you a lot about the internal strength of the stock. For instance, you’ll often find a stock trading sideways in a very narrow range and then you’ll see the money flow indicator and the on-balance volume measure start to rise and strengthen. In addition, a big portion of my actual timing and execution process involves the price action of a stock within bands.

money flow indicator and on-balance volume were both negative, that would be a sell signal (Figure 1). So you use the indicators as confirmation and as timing. A stock with favorable on-balance volume and positive money flow that moved above the upper band would look good? Right, especially if the events were well confirmed by the money flow indicator. There’s another way you can use these ideas. Suppose in your macrothinking about the markets and the economy, you felt that the semiconductor group was going to do very well. You could study the semiconductors as a group using these same techniques that we’ve discussed. What about within a group like semiconductors? You can go inside the list of semiconductor stocks and rank them based on technical criteria. For instance, Marc Chaikin developed a measurable persistency of money flow that looks at the amount of money flow that has come into a stock over the previous six months. Rank all of the semiconductor stocks according to this measure, and then buy the top several. You can keep on passing

ideas back and forth around this framework and add value to each stock. Is the break of the lower band a clear negative indication? Exactly. When you are long a stock, it can decline to such an extent that it breaks the lower band, almost no matter what you have to sell. However, we have certain rules that would generate a reentry buy signal. For instance, if 21-day money flow appeared to be very strong and you had a penetration of the lower band, that would be a reentry buy signal. I would wait until we had completed a W-type bottom — preferably the second leg of the bottom — and the right-hand side of the W was inside the trading band rather than outside of the trading band. What else turns you negative on a stock? I don’t like stocks that are able to develop substantial downside momentum. The price action is trying to tell you something negative about the issue. Is this selling with increased volume? Yes, we look at what is known as ease of movement, which has been talked about a number of ways. Edwin Quinn of Investographs originally introduced it in the 1930s, and then Richard Arms picked

How do you use the bands for trading? If a stock is within a trading range and sells off and tags the lower band but the short-term on-balance volume and money flow indicator readings are very positive, that’s a buy signal. Conversely, if after receiving a buy signal, prices rallied up and tagged my upper trading band and

Courtesy MetaStock

The famous Bollinger Bands? Could you briefly describe the bands? In essence, you’re using moving standard deviations to plot bands around a moving average. The bands themselves are easy to construct. First, calculate the 20-day moving average of the closing price and the 20-day standard deviation of the closing price. The upper trading band is two standard deviations above the 20day moving average and the lower band is two standard deviations below the 20-day moving average. Most charting software have the Bollinger Bands or you can create the bands in a spreadsheet.

FIGURE 1: NYSE COMPOSITE. The upper chart is the 21-day money flow indicator and the lower chart has the Bollinger Bands overlaid on the daily bar chart of the NYSE. In early February, the NYSE tagged the upper Bollinger Band, with low money flow giving a sell alert. During April, the NYSE failed to reach the upper band, with money flow turning negative — a sell signal. The sell is confirmed by a tag of the lower band with negative money flow.

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

Does a stock’s reaction to news tie into the ease of movement idea? One of the most bullish things a stock can do is make the best of the good news and ignore the bad news. One of the most bearish things that a stock can do is to make the worst of bad news and ignore good news. I watch a stock’s reaction to news with the price performance near the bands. Often, one of the ways that marks the transition from the first phase, where good news is emphasized, to the second phase, where bad news is emphasized, is that all of a sudden the stock is able to get down to its lower band. Prior to this phase, the stock may have been confined to trading between the middle band and the upper band or perhaps outside the upper band. Speaking of news, one stock group that has received plenty of bad news is the health group. What are your thoughts about bad-news opportunities? If we go back and look at a number of classic market situations, you will see patterns that are similar to the health stocks. One of them would be the big advance of gold into 1980, when gold essentially staged a parabolic rise in price and then crashed from its high levels. This was a situation with a tremendous multihundredpercent gain that ended in a vertical rise and was followed by a precipitous reversal, with about half the gain ultimately being lost (Figure 2). This is a classic pattern that has been repeated time and time again. What happens next is the stock, commodity or security usually becomes dormant for a long period. Gold is a very extreme example because it moved from $35 an ounce to more than $800 an ounce and then pulled back roughly half

that gain into the 300 to 400 area, where it has remained for 13 years. Although there has been some trading action during that time, it would have been more profitable to concentrate your efforts elsewhere. Any other examples? Another example is the transportation issues in late 1989 (Figure 3) when people believed companies such as United Air-

lines (Figure 4), Delta Airlines and American Airlines could do no wrong. They were the finest cash flow machines that had ever been seen and there was a tremendous vertical advance in the transportation average that went into an all-time high. How long did that last? Not long. The advance was reversed

Courtesy Telescan

up on the ideas. They plotted charts with the horizontal axis as volume instead of time. He measured the width of price volume and then compared the height of the box to the width of the box to develop an ease of movement measure. I look at ease of movement of a stock. The stocks with the ability to move against you in a powerful way are trying to give you a message; although the stocks may remain attractive for other reasons, I tend to stay away from those situations.

FIGURE 2: GOLD, LONDON PM FIX. Gold climbed from $35 an ounce to just over $850 an ounce and then ultimately lost 60% of its value. After a spectacular run, a market will often enter into a long-term trading range the way gold did.

FIGURE 3: DOW JONES TRANSPORTATION INDEX. After the 1987 crash, the transports resumed the upward trend. However, after the blowoff top in 1989, the index did not make new highs until three years later.

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

FIGURE 4: UNITED AIRLINES. Since the peak in prices in 1989, UAL has been in a large trading range.

sharply. But many investors jumped on the bandwagon because they perceived these stocks as a relative bargain because of where they had been. People waited a long time to make money in those issues, and I think that they will continue to wait. The medical stocks recently are another example (Figure 5). Very high-quality companies like Merck [MRK] (Figure 6) and Glaxo [GLX] staged multiyear, multihundred-percent advances and then in the final stages went close to vertical, but now those stocks have broken down and they can move sharply to the downside.

H

ow long does a market take to recover from this type of speculative fervor? Investors are really best served by standing away from these issues for at least a full market cycle until the influence of these tremendous market moves in the stocks’ past is essentially forgotten by the current generation of investors. I’m not suggesting that there isn’t money to be made in these issues; I‘m suggesting that there are better places to do so than in yesterday’s hero stocks or commodities (Figure 7). FIGURE 5: MEDICAL STOCKS. Health-care stocks reached a dramatic peak at the end of 1991.

FIGURE 6: MERCK & CO. Merck was a great performer during the 1980s. Since the peak in 1991, however, the stock has lost more than 40%.

Copyright (c) Technical Analysis Inc.

How do you generate trading ideas? Are they based on experience and technical analysis or are other factors involved? I spend a lot of my time reflecting on the markets, on the U.S. economy and the global economy and how those pieces fit together. I try to figure out who the likely beneficiary of good news is, and who’s going to be hurt. That’s the macro level, if you will, and even there I employ a very quantitative approach that is very much akin to technical analysis. In fact, if you want to find a technician in the fundamental community, look at the quantitative analysis department; these really are just technicians under another name. Your question also has something to do with an intuitive approach versus a mechanical approach. In that case, what do you think of mechanical approaches? I spent a good deal of my career pursu-

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

ing a mechanical approach to the market. In the beginning, I thought that it was simply a matter of finding the right moving average with the right trading rule. Eventually, my research led to finding the right group of trading bands and the right group of trading rules to go with it. Ultimately, I decided that the more adaptive the approaches were — that is, the less mechanical and more sensitive to the evolving market — the better they worked.

F

or example, your trading bands? If you look at the history of trading bands you would see a process or evolution. The first bands were simply a moving average that was shifted up and down by some percentage, say, plus or minus 4%. Then Marc Chaikin suggested that we could use unequal bands and that those bands should be adjusted so that they contained a certain percentage of the previous year’s worth of market action. He took the original trading approach and made it adaptive. I took that a step further on an ongoing basis and used a measure of volatility to set our band width. I believe this is the best approach available. It is very adaptive; the bands change according to evolving market conditions. The more a mechanical approach can be adaptive, the more it can change to the evolving market and the greater the chance of success it has.

some of the tools you use there? The bond market presents a somewhat tougher process. Volume information is very hard to come by. I have used some measures of futures market activity as a surrogate for bond market volume, but a lot of the variables that we have to aid us in the stock market are unavailable for the bond market. So for the bond market, I rely more on a relational approach. I look very carefully at the various measures of money supply and some of the economic variables. I look at inflation-sensitive variables such as commodity prices, gold and energy prices. The bond market tends to be a strong trending market in a much more meaningful way than the stock market. Trend analysis is very helpful in the bond market.

fact, in the latter stage we would consider it to be a market of stocks and not the stock market.

How about in the stock market? My work suggests that trend analysis is almost useless in the stock market.

How so? Trendiness suggests that trend-following techniques like moving average analysis are useful. I do not find those methods useful in relation to the stock market, but I find them very useful in relation to other markets, such as the currency market. In the stock market, I find reversal techniques and the pattern-recognition techniques far more useful — W bottoms, M tops, and so on — and they seem to add tremendous value to market timing. These same methods are less valuable in the currency markets, where it’s much more important to pay attention to the trend of things than try to identify reversals and take the opposing position.

So you don’t worry about the direction of the stock market. You look for individual long and short ideas? In the stock market, essentially there are two phases of market activity. One of those is a time when the market is indeed a stock market, when the vast majority of stocks behave alike, rising and falling along with the market itself. Another phase of market activity is when the individual stocks have a very wide dispersion. Some of these stocks are involved in bull moves, while some are involved in bear moves. In

Where are we now? I believe the latter stage is the current phase of the market. In this latter situation, where we are in a market of stocks, we like the idea of being long some things and short some others; stock picking pays off in that environment and we’ve used certain statistical measures of price dispersion to try to figure out which phase of the market we’re in. When stock prices are very tightly linked, and everything is rising and falling in tune with each other, then it is very much a stock market. That, though, is separate from the idea of trendiness.

Do you have any other examples of adaptive technical methods? We need to think about how to capture some of the variables that have traditionally been in the fundamentalist’s toolkit and bring them to mechanical trading systems. A simple variable might be interest rates. Change the sensitivity of your trading system as interest rates change, say, rather than some characteristic of the underlying security that you were trying to trade. Adaptive approaches will add tremendous value to the investment process; after all, that’s what this is all about, making money. Another popular market for making money is the bond market. What are

FIGURE 7: PHILIP MORRIS. Another star performer during the 1980s, Philip Morris has stumbled and is likely to move in a long-term trading range.

Copyright (c) Technical Analysis Inc.

Courtesy CompuTrac

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

FIGURE 8: WEEKLY TREASURY BOND FUTURES, 1990-93. The bond market has been in a long-term uptrend since fourth-quarter 1990.

FIGURE 9: TREASURY BOND SENTIMENT. The bullishness in bonds has been somewhat subdued.

FIGURE 10: EURODOLLAR SENTIMENT.The bullish sentiment in Eurodollars has been quite high. Upside progress in Eurodollars may be limited because expectations are very high.

Copyright (c) Technical Analysis Inc.

How do you use this information? In a trend-following mode, the analyst’s job is to identify a trend as it emerges and to buy or sell in harmony with that trend. That’s useful for markets with trending characteristics. In markets without trending characteristics, you have to identify reversal patterns that you know lead to advances or declines. Often, in these markets, by the time you recognize a trend, it’s too late because you’re getting awfully close to the next reversal. One of the signatures of a nontrending market is the number of reversal patterns. In nontrending markets, you tend to pick up a large number of reversal patterns. In trending markets, you pick up relatively few reversal patterns. How do you measure or quantify reversal patterns? Initially, I visually studied the charts. I went through year after year of charts and identified all the important places where you needed to make a reversal in strategy, and then went back and looked at the pattern of volume across that time, the price patterns across that time, the patterns of indicators across that time, and pick out certain groupings of events, certain patterns of market action that happen in those reversal phases. From that, I could derive rules — if x, y, z happens, then these are the kinds of things that are often found in a reversal. The more you find, the higher the confidence of the reversal. People researching neural networks and artificial intelligence and pattern recognition will recognize the building blocks of those systems. Have you researched having the computer discover price patterns? I haven’t been successful in getting computers to recognize those building blocks for me, but I have been successful in examining the markets and detecting these patterns. The greatest use of computers in this field is testing ideas. I have a lot of ideas about different markets, trading strategies and different things we can do; there’s no shortage of ideas. What I want to do, though, is find ideas that are quantifiable, ideas

Stocks & Commodities V. 11:7 (277-284): John Bollinger Of Bollinger Capital Management by Thom Hartle

that I can go out and test in the real world, develop some confidence in and then find out how to implement them in the market. Can you give me any examples? Ralph Vince, for instance, has suggested in his work some techniques for determining the optimum investment size. Other ideas: if you have a trading system with positive expectations, applications of Martingale systems can be used to optimize the returns that the system has. People think that these techniques can take a poor trading system and make it into a great one, but that is simply not true. These techniques can go a long way toward taking a good system and making it a great one, but if the system itself were incapable of making money to start with, none of these techniques can make it profitable. A good method with good management. What about diversification? At Bollinger Capital Management, we attempt to introduce as much diversification as possible. In the past, diversification has meant doing things essentially to hedge a portfolio. From our point of view, the well-diversified portfolio is one with a good number of ideas that are all potentially profitable. We have looked at many different markets in many different phases of the economic cycle to find usable investment ideas. For instance, currently, we are about 20% committed to the U.S. equity market in terms of long positions, and we have a simultaneous 10% short position. What’s your long and short philosophies? Long positions are positions in companies that I believe will benefit in the next phase of the economy. The short positions, however, are hero stocks that are fading, losing the glow, very much the kind of stocks I mentioned that once reacted only to good news and now are starting to react to bad news. In addition, we have a 20% exposure to international equities, which is done almost exclusively through the international country funds. We maintain a 30% exposure to the bond market, both long-term

For the bond market, I rely more on a relational approach. I look very carefully at the various measures of money supply and some of the economic variables. I look at inflation-sensitive variables such as commodity prices, gold and energy prices. The bond market tends to be a strong trending market in a much more meaningful way than the stock market. Trend analysis is very helpful in the bond market.

and intermediate-term U.S. Treasuries. We keep a small cash reserve of 10% mainly for margin, for interesting ideas that come along from time to time that we want to take advantage of. Is that it? What else? Currently, we have a 10% portion of the portfolio that was devoted to the gold market but is now devoted to South African stocks that we believe are the perfect contrarian play. We simply can’t find anyone who likes them — the stocks are tremendously cheap from a long-term point of view, and as the global economy bottoms out, we feel these stocks with tremendous exposure to the natural resource part of the economic cycle will do very well. In addition, we believe that South Africa will find a peaceful solution to its political problems — it has been doing so now for a couple of years, and we believe this trend will continue and that the overall return on these issues will be very positive. And I just love the idea of an insurance policy that pays for itself. As we wind down here, is there anything you’d like to address? Beyond a shadow of a doubt, the psychology of market participants is the most important variable. It’s not sufficient to buy a stock that’s cheap or that has good money flow or that has good on-balance will shave their earnings estimate from $1.60 to $1.58 and it will lose a point and a half. Copyright (c) Technical Analysis Inc.

All of a sudden, the psychology of market participants will go from blind belief to the beginnings of doubt. And therein is the sell signal, and a little bit later, as the stock rolls over and the good news starts to be ignored, a short signal. In assessing the market’s reaction to the news and the psychology of the participants, I think, the average investor can really add a tremendous amount of value to their investment process. On that note, thanks, John. You’re welcome.

ADDITIONAL READING Arms, Richard W., Jr. [1990]. “Ease of movement,” Technical Analysis of STOCKS & COMMODITIES, Volume 8. Bollinger, John [1993]. “Put volume indicator,” STOCKS & COMMODITIES, March. _____ [1992]. “Using Bollinger Bands,” Technical Analysis of STOCKS & COMMODITIES, Volume 10: February. “Capital Growth Letter,” Bollinger Capital Management, PO Box 3358, Manhattan Beach, CA 90266, 310-5450610. MacKay, Charles [1932]. Extraordinary Popular Delusions and the Madness of Crowds, now published by Fraser Publishing, Burlington, VT. Neill, Humphrey [1963]. The Art of Contrary Thinking, Caxton, Caldwell. S&C

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

Using Bollinger Bands by John Bollinger

Trading bands, which are lines plotted in and around the price structure to form an envelope, are the action of prices near the edges of the envelope that we are interested in. It's not the newest of ideas, but as John Bollinger of Bollinger Capital Management points out, it's one of the most powerful concepts available to the technically based investor, answering not whether absolute buy and sell signals are being given but whether prices are high or low on a relative basis. Trading bands can forewarn whether to buy or sell by using indicators to confirm price action. How do trading bands work? Bollinger, of Bollinger Bands fame, explains how.

T

rading bands 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. But before we begin, we need a definition of what we are dealing with. Trading bands are lines plotted in and around the price structure to form an ''envelope". It is the action of prices near the edges of the envelope that we are particularly interested in. The earliest reference to trading bands I have come across in technical literature is in The Profit Magic of Stock Transaction Timing ; author J.M. Hurst's approach involved the drawing of smoothed envelopes around price to aid in cycle identification. Figure 1 shows an example of this technique Note in particular the use of different envelopes for cycles of differing lengths.

Article Text

Copyright (c) Technical Analysis Inc.

1

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 1: The trading bands or envelopes are first drawn by hand over the price series. An average width is determined by measuring the distance from the top and bottom of the bands.

Figures

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

Asking the market what is happening is always a better approach than telling the market what to do. 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. A good example appears in Figure 2, where an envelope has been constructed around the Dow Jones Industrial Average (DJIA). The average used is a 21-day simple moving average. The bands are shifted up and down by 4%. The procedure to create such a chart is straightforward. First, calculate and plot the desired average. Then calculate the upper band by multiplying the average by 1 plus the chosen percent (1 + 0.04 = 1.04). Next, calculate the lower band by multiplying the average by the difference between 1 and the chosen percent (1- 0.04 = 0.96). Finally, plot the two bands. For the D JIA, the two most popular averages are the 20- and 21-day averages and the most popular percentages are in the 3.5 to 4.0 range. CHAIKIN'S

INNOVATION

The next major innovation came from Marc Chaikin of Bomar Securities, who, in attempting to find some way to have the market set the band widths rather than the intuitive or random-choice approach used before, suggested that the bands be constructed to contain a fixed percentage of the data over the past year. He stuck with the 21-day average and suggested that the bands ought to contain 85% of the data. Bomar bands were the result. Figure 3 depicts this powerful and still very useful approach. The width of the bands is different for the upper and lower bands. In a sustained bull move, the upper band width will expand and the lower band width will contract. The opposite holds true in a bear market. Not only does the total band width change across time, the displacement around the average changes as well. BOLLINGER'S

BRAINSTORM

Asking the market what is happening is always a better approach than telling the market what to do. In the late 1970s, while trading warrants and options and in the early 1980s, when index option trading started, I focused on volatility as the key variable. To volatility, then, I turned again to create my own approach to trading bands. I tested any number of volatility measures before selecting standard deviation as the method by which to set band width. I became especially interested in standard deviation because of its sensitivity to extreme deviations. As a result, Bollinger Bands are extremely quick to react to large moves in the market. Bollinger Bands are plotted two standard deviations above and below a simple moving average. The data used to calculate the standard deviation are the same data as those used for the simple moving average. In essence, you are using moving standard deviations to plot bands around a moving average. The time frame for the calculations is such that it is descriptive of the intermediate term trend. (See Figure 4 for a precise mathematical definition and the formula.) Figure 5 again depicts the DJIA, this time with Bollinger Bands. Note the bands' responsiveness to changing market conditions. The width of the bands varies by more than three times from point A to point B; note that many reversals occur near the bands and that the average provides support and resistance in many cases.

Article Text

Copyright (c) Technical Analysis Inc.

2

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 2: The concept emerged in the 1970s of shifting a moving average up and down by a certain number of points or a fixed percentage to obtain an envelope around price. Here, an envelope has been constructed around the Dow Jones Industrial Average (D JIA). The average used is a 21-day simple moving average. The bands are shifted up and down by 4%.

FIGURE 3: Marc Chaikin, to find some way to have the market set the band widths rather than the intuitive approach used before, suggested that the bands be constructed to contain a fixed percentage of the data over the past year. He stuck with the 21-day average and suggested that the bands ought to contain 85% of the data. Bomar bands were the result.

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 4: Bollinger Bands are plotted two standard deviations above and below a simple moving average. The data used to calculate the standard deviation are the same data as those used for the simple moving average. In essence, you are using moving standard deviations to plot bands around a moving average. The time frame for the calculations is such that it is descriptive of the intermediate-term trend. For the mathematically inclined, the middle band is the n-day mean. The upper band is the n-day mean plus twice the root mean squared deviation from that mean, while the lower band is the n-day mean minus twice the root mean squared deviation from that mean where n is chosen such that it describes the intermediate-term trend.

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 5: Here is the DJIA ,this time with Bollinger Bands. Note the bands ' responsiveness to changing market conditions. The width of the bands varies by more than three times from point A to point B, note also that many reversals occur near the bands and that the average provides support and resistance in many cases.

FIGURE 6: The easiest way to identify the proper average is to choose one that provides support to the correction of the first move up off a bottom. U the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is currently chosen will provide support far more often than it is broken.

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

There is great value in considering different measures of price. The typical price, (high + low + close) / 3, is one such measure that I have found to be useful. The weighted close, (high + low + close + close) / 4, is another. To maintain clarity, I will confine my discussion of trading bands to the use of closing prices for the construction of bands. My primary focus is on the intermediate term, but short- and long-term applications work just as well. Focusing on the intermediate trend gives one recourse to the short and long-term arenas for reference, an invaluable concept. For the stock market and individual stocks, a 20-day period is optimal for calculating Bollinger Bands. It is descriptive of the intermediate-term trend and has achieved wide acceptance. The short-term trend seems well served by the 10-day calculations and the long-term trend by 50-day calculations.

T

he average that is selected should be descriptive of the chose; time frame. This is almost always a

different average length than the one that proves most useful for crossover buys and sells. The easiest way to identify the proper average is to choose one that provides support to the correction of the first move up off a bottom. If the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is correctly chosen will provide support far more often than it is broken. (See Figure 6.) Bollinger Bands can be applied to virtually any market or security. For all markets and issues, I would use a 20-day calculation period as a starting point and only stray from it when the circumstances compel me to do so. As you lengthen the number of periods involved, you need to increase the number of standard deviations employed. At 50 periods, two and a half standard deviations are a good selection, while at 10 periods one and a half do the job quite well. In most cases, the nature of the periods is immaterial; all seem to respond to correctly specified Bollinger Bands. I have used them on monthly and quarterly data, and I know many traders apply them on an intraday basis. ANSWERING THE

QUESTIONS

Trading bands answer the question whether prices are high or low on a relative basis. The matter actually centers on the phrase "a relative basis." Trading bands do not give absolute buy and sell signals simply by having been touched; rather they provide a framework within which price may be related to indicators. Some older work stated that deviation from a trend as measured by standard deviation from a moving average was used to determine extreme overbought and oversold states. But I recommend the use of trading bands as the generation of buy, sell and continuation signals through the comparison of an additional indicator to the action of price within the bands.

Bollinger Bands can be applied to virtually any market or security. For all markets and issues, I would use a 20-day calculation period as a starting point and only stray from it when the circumstances compel me to do so. If price tags the upper band and indicator action confirms it, no sell signal is generated. On the other

Article Text

Copyright (c) Technical Analysis Inc.

3

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

hand, if price tags the upper band and indicator action does not confirm (that is, it diverges), we have a sell signal. The first situation is not a sell signal; instead, it is a continuation signal if a buy signal was in effect. It is also possible to generate signals from price action within the bands alone. A top (chart formation) formed outside the bands followed by a second top inside the bands constitutes a sell signal. There is no requirement for the second top's position relative to the first top, only relative to the bands. This often helps in spotting tops where the second push goes to a nominal new high. Of course, the converse is true for lows. INTRODUCING %B AND BAND WIDTH An indicator derived from Bollinger Bands that I call %b can be of great help, using the same formula that George Lane used for stochastics. The indicator %b tells us where we are within the bands. Unlike stochastics, which are bounded by 0 and 100, %b can assume negative values and values above 100 when prices are outside of the bands. At 100 we are at the upper band, at 0 we are at the lower band, above 100 we are above the upper bands and below 0 we are below the lower band. See Figure 7 for the exact formula. Indicator %b lets us compare price action to indicator action. On a big push down, suppose we get to -20 for %b and 35 for relative strength index (RSI). On the next push down to slightly lower price levels (after a rally), %b only falls to 10, while RSI stops at 40. We get a buy signal caused by price action within the bands. (The first low came outside of the bands, while the second low was made inside the bands.) The buy signal is confirmed by RSI, as it did not make a new low, thus giving us a confirmed buy signal.

T

rading bands and indicators are both good tools, but when they are combined, the resultant approach

to the markets becomes powerful. Band width, another indicator derived from Bollinger Bands, may also interest traders. It is the width of the bands expressed as a percent of the moving average. When the bands narrow drastically, a sharp expansion in volatility usually occurs in the very near future. For example, a drop in band width below 2% for the Standard & Poor's 500 has led to some spectacular moves. The market most often starts off in the wrong direction after the bands tighten prior to really getting under way, of which January 1991 is a good example (Figure 9). AVOIDING

MULTIPLE COUNTS

A cardinal rule for the successful use of technical analysis requires avoiding multicolinearity amid indicators. Multicolinearity is simply the multiple counting of the same information. The use of four different indicators all derived from the same series of closing prices to confirm each other is a perfect example. So one indicator derived from closing prices, another from volume and the last from price range would provide a useful group of indicators. But combining RSI, moving average convergence/divergence (MACD) and rate of change (assuming all were derived from closing prices and used similar time spans) would not. Here are, however, three indicators to use with bands to generate buys and sells without running into problems. Amid indicators derived from price alone, RSI is a good choice. Closing prices

Article Text

Copyright (c) Technical Analysis Inc.

4

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 7: This indicator tells us where we are within the bands. Unlike stochastics, which are bounded by 0 and 100, %b can assume negative values and values above 100 when prices are outside of the bands. At 100 we are at the upper band at 0 we are at the lower band, above 100 we are above the upper bands and below 0 we are below the lower band. Also shown is the formula for band width.

FIGURE 8: Selecting the relative strength index (RSI) as our confirming indicator, we can observe that at A, the dollar index moved above the upper band while the RSl made a new high (confirmation). At B, the dollar index edged close to the upper band while the RSI failed to confirm (divergence). C constitutes a nonconfirmed retest of B.

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

FIGURE 9: When the band width indicator falls, the implication is that volatility is declining. At some point, the volatility returns. A drop in the band width to below 2% for the S&P 500 has led to some spectacular moves (such as January).

Stocks & Commodities V. 10:2 (47-51): Using Bollinger Bands by John Bollinger

and volume combine to produce on-balance volume, another good choice. Finally, price range and volume combine to produce money flow, again a good choice. None is too highly colinear and thus together combine for a good grouping of technical tools. Many others could have been chosen as well: MACD could be substituted for RSI, for example. The Commodity Channel Index (CCI) was an early choice to use with the bands, but, as it turned out, it was a poor one, as it tends to be colinear with the bands themselves in certain time frames. The bottom line is to compare price action within the bands to the action of an indicator you know well. For confirmation of signals, you can then compare the action of another indicator, as long as it is not colinear with the first. John Bollinger, CFA, CMT, PO Box 3358, Manhattan Beach, CA 90266, (310) 545-0610, is president and founder of Bollinger Capital Management and publishes the monthly "Capital Growth Letter," a market letter for the average investor employing a technically driven asset allocation approach. He is also market analyst for CNBC/FNN

FOR FURTHER READING Hurst, J.M. [1970]. The Profit Magic of Stock Transaction Timing , Prentice-Hall. Star, Barbara [1992] . "The Commodity Channel Index," STOCKS & COMMODITIES, February.

Figures

Copyright (c) Technical Analysis Inc.

5