My Yahoo!Bollinger Bands 101
NEW YORK - John Bollinger, founder and president of Bollinger Capital Management and editor of the Capital Growth Letter, is still best known for Bollinger Bands, the technical indicator that bears his name. In the late 1970s, Bollinger was one of the first practitioners to use a personal computer and widely available market data to do technical analysis modeling. "We developed a neat little trading system for the Dow using a 21-day moving average and minus/plus 4% trading bands. We used the computer to compare the price action within the trading bands," Bollinger recalls. "But you had to constantly recalibrate it." So he realized that he had to adjust his figuring for volatility.
The watershed came when Bollinger started experimenting with standard deviations to measure volatility. As he explains it: "I realized the key was to measure volatility the same way as a moving average, not as something static, but something constantly in flux." After some trial and error, he hit upon his formula, a 20-day moving average with bands at two standard deviations.
Market technicians use these trading bands to see how relatively high or low a stock is trading. When a stock gets close to its high or low band, chartists look for patterns, such as "double bottoms" or "head and shoulders," which have tended to mean a stock is bottoming out or peaking.
In a double-bottom, or W formation, the second price low should be farther above the lower Bollinger band than the first. Thus, if the first low breaks below the lower band, the second should not, even though the actual price can be lower in the case of a stock that is trending down. This can clearly be seen on the chart of AT&T Wireless (nyse: AWE - news - people ) below. The first low (A) clips the lower Bollinger Band (blue line); the second low (B), although the price is lower, is a greater distance above the lower band. "This is called a setup and it's a bullish indicator. You should then watch for a signal of strength--a day of above-average volume or above-average price range--to confirm the analysis," according to Bollinger. That is exactly what happened in the case of AT&T Wireless. The low was followed by a runup in the price from $17 to $20 (C) and from there, the stock broke out to a high of over 27 by the end of the next month. Thankfully you needn't be a math whiz or computer programmer to use Bollinger Bands in your stock picking. Most financial sites generate charts that automatically display them. Stay tuned: On Thursday, Bollinger will give us one of his current favorite picks.
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