My High Dividend Stocks Blog: TIP OF THE WEEK - The Usefulness of Bollinger Bands

The Usefulness of Bollinger Bands

Jason Brizic

June 8, 2011

Bollinger Bands are a technical trading tool created by John Bollinger in the early 1980s. They arose from the need for adaptive trading bands and the observation that volatility was dynamic, not static as was widely believed at the time.

The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition prices are high at the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions.

Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average. The default parameters, 20 periods and two standard deviations, may be adjusted to suit your purposes.

You can use Bollinger Bands to help you time your purchase of high dividend stocks, commodities, and contrarian stocks. Price bottoms tend to occur when the stock price lifts off the long downward slide down the lower band. Price tops tend to occur when the stock price falls from hitting its head on the top of the upper band. I use the MACD and CCI in conjunction with the Bollinger Bands to confirm a top or bottom because just using the Bollinger Band alone can get you burned (the UNG example below).

I use Bollinger Bands when I create free charts on www.stockcharts.com.

Here are the steps I take to setup my charts in less than 10 seconds:

Leave the Type of chart: set to SharpChart.
Type in the ticker symbol and click Go.
Change the Period to Weekly.
Scroll down to Chart Attributes; change Size to Landscape.
Check the following checkboxes: Full Quote, Price Labels,
Uncheck the Log Scale checkbox.
Scroll down to the Overlays area. Change the one that says –None- to Bollinger Bands
Scroll down to the Indicators area. Change the one that says RSI to CCI

I discovered the usefulness of Bollinger Bands when I tried to time the recent bottom in the gold price back in 2008 Here is the 3 year gold price chart:

http://stockcharts.com/h-sc/ui?s=$GOLD&p=W&b=5&g=0&id=p99091791121

When was the best time to buy gold on this chart? $681 in late October 2008. What happened right after that point? The price lifted off the bottom Bollinger Band. The CCI was deep in the red and the MACD turned upward from negative territory. Those confirmed the bottom. I bought at $820.

The natural gas ETF trading as UNG provides a good example of how the solely relying on the Bollinger Bands alone can trick you into buying too high. Look at this chart:

http://stockcharts.com/h-sc/ui?s=UNG&p=W&b=5&g=0&id=p99958479096

Wow! This fund has lost a lot of money. The price of UNG lifted off the bottom Bollinger Band many times, but never enough to bust through the middle band. The CCI and MACD indicators were good at around March 2009, but the price didn’t break through the middle BB. Knowing the fundamentals of UNG were horrible was enough to stay away from the fund. However, just carefully examining the technicals was also enough.

I use the fundamentals to decide to buy or sell. Then I use the technicals to time my entry or exit. I will write about the CCI and MACD in upcoming tips of the week.

The fundamentals of Safe Bulkers were strong during the big market crash of 2008-2009. You could have used Bollinger Bands to get this gem at around $3.00 per share.