ANOTHER LOOK AT BOLLINGER BANDS -- HOW TO APPLY THEM TO DIFFERENT TIME SPANS -- AND HOW TO COMBINE THOSE TIME SPANS

DIRECTIONAL SIGNALS ON MONTHLY CHART ... I'm going to devote this article to a demonstration of the usefulness of Bollinger Bands. But first an explanation of what they are. Developed by John Bollinger, the two bands are plotted two standard deviations above and below a middle line which is usually a 20-period moving average. I say "20-period" because the bands can be used in any time dimension including 20 hours, 20 days, 20 weeks, and 20 months. Most traders seem to use the bands primarily for short-term trading purposes on daily charts. They're also very useful on longer-term charts. Let's start there. Chart 1 shows the Bollinger bands applied to a monthly S&P 500 bar chart. The (dashed) middle line is a 20-month moving average. In an uptrend (1995 to 2000 and 2003 to 2006), the price fluctuates between the middle and upper lines. In uptrends, therefore, price dips near the 20-month average act as good buying opportunities (see blue arrows). When the middle line is broken, a major sell signal is given. That happened during 2000 (red circle). During the subsequent two-year decline, prices fluctuated between the lower band the middle line. A crossing back over the 20-month line (blue circle) in 2003 gave a major buy signal. The trend has been up since then. And it will continue to be up until the 20-month moving average is broken. At the moment, the 20-month line sits about 100 points (or 7.5%) below the current price.

Chart 1

WEEKLY BANDS MEASURE INTERMEDIATE TREND ... While the monthly bands help define the long-term trend, the weekly bands help determine the intermediate trend of the market. But it's interpreted in the same way. Notice, however, that the weekly bars trend to trade more frequently at the upper and lower bands. That's especially true when the market is in a sideways trading range which was the case during the first ten months of 2005. In a trading range, prices will pull back from the upper band (red arrows) and bounce off the lower band (blue arrows). Intermediate buy and sell signals are given when the middle line is crossed. The last crossing was to the upside last November (green circle). The trend has been up since then. In an uptrend, prices will find support at the 20-week line (green arrow). It would now take a close below that middle (dashed) line to turn the intermediate trend lower. Right now, the 20-week line sits at 1285 which is 25 points (or 2.5%) below the current price. The solid line on top of Chart 2 is the %B. It plots the three Bollinger lines horizontally and acts as an oscillator. A reading over the middle line (0.50) means that the intermediate trend is up. A reading below .50 means it's down. Prices will often meet with support near 0.00 (which is the lower band) and resistance at 1.00 (the upper band). Right now it's in potential overbought territory.

Chart 2

DAILY BANDS MEASURE SHORT-TERM TREND ... Chart 3 applies Bollinger bands to a daily bar chart of the S&P since the start of the year. As you might expect, the daily bands are used primarily for short-term trading purposes. The swings between the band extremities are much more frequent on the daily charts. The upper band has been touched at least five times since the start of 2006. In most cases, the upper line acted as a short-term resistance barrier. The lower band has been touched twice (the early March low didn't quite reach the lower band). In both instances, the lower band acted as a support level. That's the way most traders use the bands. They'll sell against the upper band and buy against the lower band. Using it that way can be done more clearly by using the %B line at the top of Chart 3. It shows the three lines as an oscillator. The upper value (1.00) matches the upper band while the lower value (0.00) matches the lower band. The middle line (.50) is the 20-day average. Used that way, the 1.00 value (red line) acts as short-term resistance, while the 0.00 value (green line) acts as short-term support. The last test of that support line took place just a couple of weeks ago when the S&P bounced off its lower band. The solid line at the bottom of Chart 3 is the Band Width. It measures the width between the two outer bands. Generally speaking, the bands will expand during a strong trend, and contract at a short-term peak or trough -- or during a trading range. Although the short-term trend is up at the moment, the band width has expanded only modestly since April 10. That suggests that there isn't much power behind the current bounce.

Chart 3

COMBINING ALL THREE AVERAGES ON ONE CHART ... I often put all three moving averages on the same chart as is done in Chart 4. I do that buy converting the weekly and monthly averages to daily values. The top blue line is the standard 20-day average. The red line is the 100-day (20 week) average. [Simply convert 20 weeks to 100 days]. That defines the intermediate trend which has been rising since last November. Prices bounced off that line during the last month (red arrow). The green line is the 20-month line which I've converted into 400 days. That defines the long-term trend. Prices bounced off that last October. By looking at all three lines on the same chart, you get a sense of the short-term, intermediate-term, and long-term trends. Right now, all three are up. Using all three moving averages is one way to combine all three time spans on one chart. Chart 5 shows another way.

Chart 4

COMBINING DIFFERENT BAND SPANS ... Although most traders apply the 20-day Bollinger bands to daily charts, I actually prefer using intermediate-term signals generated by the 20-week (or 100 day) bands. That's done easily enough by converting the 20-day value on the daily bands to 100 days. That way you're getting the equivalent of weekly signals on daily charts. The middle (dashed) line in Chart 5 is the 100-day moving average (which is the equivalent of 20 weeks). The S&P 500 crossed above that line last November (green circle) and has stayed above it ever since. Prices bounced off that line in early April (green arrow). Notice that the price decline of last October bounced off the lower band. That was where the latest bull move began. Since I'm more concerned with intermediate-term trends (which can last for months), I find the 100-day bands much more useful than 20 days. At the moment, the intermediate trend is rising but the market is up against potential resistance at the upper band. A close below the 100-day line is needed to turn the intermediate trend down.

Chart 5