Look, it's no secret that I love the Bollinger Bands.
I talk about them all the time because I've been honing my skills with them more and more.
They can be an extremely effective tool in ANY market - but that goes twofold for the market we're currently in.
You see, this market continues to surprise all of us - it's disconnected and not trading on the fundamentals, but the traders that have been around for a while still use technical indicators to set their targets and get in and out of trades.
Why wouldn't they?
The markets are just a giant math equation, and the Bollinger Bands are deeply rooted in that equation.
Well, I'm going to try to break it down as best as I can to help you understand exactly what I'm looking at and why.
I use a 20,2 Bollinger Band. That means you can plot the bands by taking the average close price over the last 20 days and then taking a two-standard deviation from that price both above and below. That's how you find those beautiful blue lines.
Those two standard deviations are the secret sauce. If something, anything, in the market or elsewhere falls beyond two standard deviations of the average, it's considered an outlier.
So, a break or even a touch of the Bollinger Bands tells you the price activity on any given stock is starting to become unusual and volatility is starting to brew.
As I always say, volatility is a trader's best friend... If a stock isn't moving, there is no money to be made... Or is there?
This information is worthless unless you can get ahead of the move. After all, once the stock breaks the band and the volatility moment has passed, the stock will consolidate at the new price and the trade is gone.
That's where one of my favorite patterns comes in - the Bollinger Band squeeze
There are times when these bands actually tighten to a smaller-than-normal gap between the two. This tells me it might be time to get in on something...
Of course, this isn't just based on them being visually closer. In fact, a stock with more volatility will always have wider bands.
My approach is to compare the width of the bands to the width the stock has experienced over the last year. If the Bollinger Band width gets close enough to where 90% of the time they are wider then their current state, I start to get fired up.
But just like whoever is picking Dwayne "The Rock" Johnson's t-shirts, the tighter the better.
If you see bands that are at the tightest they have been over the last year, you might just catch me foaming at the mouth on stream.
You see, when the bands tighten in this fashion, it is typically followed by a moment of extreme volatility, allowing you to grab profits quickly.
At face value, this makes sense. With a Bollinger Band that's tighter than normal, it's going to be a lot easier to see a break happen.
When you start peeling back the layers a bit, there's more to it. Think about this... If a stock is largely moving sideways, would you just let your money sit there, or are you going to shift those funds around to put them to work?
Yeah, everybody else is going to adjust their positions as well, and that can be a major driver in a stock's volatility moment.
Before we go any further, I want to make one thing clear: Volatility is NOT directional - it's simply telling you that things are moving.
For all you market scientists out there, the Bollinger Band squeeze is the market's potential energy building. Well, the volatility is the market's potential energy converting into kinetic energy, making the stock move.
But to find the direction this volatility explosion is going to go, you will need to defer to other indicators - in most cases the moving average (MA) lines to find the trend in the stock or ETF.
Now, I've been working on a little project to help me optimize our trading technique.
I've already started to share this with my Night Traders, as they got a sneak peek of my filter to find these Bollinger Band contractions.
And yesterday, my filter found nearly 600 different signals on both the bullish and the bearish side of things.
I pulled those signals into my database and this is the result:
I get it - 600 companies is a bit overwhelming. But there is one particular sector here that caught my eye, and that's the SPDR S&P Retail ETF (XRT).
26% of the companies in XRT are showing contracting Bollinger Bands. We are seeing retail headlines all over the place, and this is a sector that is poised to implode.
So, using the filter I drilled down further to look at which companies in XRT are flashing a signal, and this is what I found:
These are the companies that you need to be watching right now.
Over the next couple of days, you are going to see some explosive movement in practically all of these companies.
But this morning we did a special "charts-by-request" segment using these companies. I flashed this up on the screen and asked all of you which of the charts you wanted to have me break down.
This resulted in several tradable opportunities for everybody that was there.
If you missed it, you're in luck. Our South Canadian, tanktop-clad friend Brandon recorded it for you, and a lot of these ideas are still ripe for the picking:
The post How to Trade XRT Using the Bollinger Bands appeared first on Penny Hawk.
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.