The stock market tends to move from low volatility trading ranges to high volatility trend moves. The trained trader can use this knowledge to make key trading decisions. Once they recognize a low volatility market, they can now predict that a high volatility trend move will occur in the short term.
One of the best ways to identify that the market is in a low volatility trading range is to use Bollinger Bands. When the Bollinger Bands narrow down and come close together it shows an extremely low volatility market. This market, as you have now learned, is screaming to those willing to hear, that a great money making opportunity is there for the taking. Narrowing of bands does not tell the direction the big volatility trend will be, but basic technical analysis can give tips on which way the big break out will be.
In May 2008, the Bollinger Bands pull in closely on the Caterpillar (CAT) chart throwing up the signal that a large volatility trend would be following soon. This set up the perfect opportunity for a short sale in mid June as the stock plummeted from the $80 dollar price range down to the $65 dollar area.
Bollinger Bands are also useful for the long term investor. As can be seen in the chart below, Potash (POT) breaks out of a multi year trading base in August of 2004 — more than doubling in price a year later. In June 2006, the Bollinger bands on the monthly chart again narrow. This was an investor’s dream signal as it alerted them to a trading opportunity just before the stock soars over 900% in 2 years as the price rises from the $26 range to the $240 range in June of 2008.
Apple (AAPL) computer gave two trade opportunities using Bollinger Bands. The first was in January 2009. The bands narrowed just before the stock price rose from $78 to $103. An even bigger opportunity came in March 2009. The bands again narrowed just before price rose from $82.57. The high of this move, as of this writing is around $109 with a possibility for prices to go even higher as the price bars walk the upper Bollinger band and the upper and lower bands pull apart.
Lundin (LMC) was a poor man’s dream as stock prices rose over 150% from 57 cents in the beginning of March 2009 to $1.56 on March 27th 2009 and looks like it wants to continue to climb the price ladder. Again the Bollinger Bands were the trader’s advocate by flashing a sign that a high volatility trend was about to take place as the upper and lower bands narrowed in late February.
Examples using Bollinger Bands
These are powerful examples of how Bollinger Bands can be an effective tool in the stock trader’s toolbox. Mastering any new concept always takes practice and patience. With Bollinger Bands it is no different. As you continue to try new strategies, while playing the Wall Street Survivor stock game, add Bollinger Bands to the mix. Soon, you will find your favorite distance when bands narrow and give you a long or short opportunity.
A favorite strategy uses the upper and lower bands as an entry point. If you feel the stock is going to rise, you wait until the Upper and Lower bands come close together and price touches or goes below the lower band. You then wait until the price rises back up above the lower band for your entry point to go long. The same is true if you feel the price is going to fall. Wait until the bands again signal a low volatility trading range. When prices rise above the upper band go short as price comes back down through the upper band showing that there is not enough power on the up side to keep the stock price rising.