S&P 500 REMAINS ABOVE ITS 20-DAY AVERAGE KEEPING THE SHORT-TERM UPTREND INTACT -- THREE WAYS TO USE BOLLINGER BANDS ON DAILY CHARTS

USING BOLLINGER BANDS ON DAILY CHARTS... Stocks bounced back from Monday's selloff. As a result, it's difficult to decide if the rally off the March 9 bottom is over or just pulling back a bit. If it does pullback, how far? One valuable tool to help find some answers is Bollinger bands. Chart 1 plots the two bands around a daily chart of the S&P 500. The middle (dashed) line is the 20-day moving average. The two outer bands are placed two standard deviations above and below the middle line. Approximately 96% of the price action takes place within the outer bands. As a result, they act as outer price limits. The key to short-term market direction is the middle line. During an uptrend, prices usually fluctuate between the upper band and the 20-day line. That's been the case since mid-March. Prices bounced off the 20-day line today. A close below that support line usually signals a deeper correction which drops to the lower Bollinger band. The lower band currently sits at 787 which coincides roughly with the late March reaction low. A drop to the lower band would come close to a 38% retracement of the six-week rally. The uptrend remains intact until prices close below the 20-day average. If it does, prices can be expected to drop down to the lower Bollinger band. A downturn in the 20-day line itself is further evidence of short-term weakness. In case you're not aware of it, there are two other indicators you can employ that use the same lines in Chart 1.

Chart 1

%B ACTS AS AN OSCILLATOR... By scrolling down the Stockcharts Indicator List, you'll see an indicator called %B. That indicator is placed at the bottom of Chart 2. %B turns the Bollinger bands (and the 20-day line) into a sort of overbought-oversold oscillator. In %B, the 20-day average becomes the middle line (0.5). Rallies above that line can be viewed as short-term buy signals. The last one took place in mid-March (green circle). The short-term uptrend remains intact until %B falls below the 0.5 line. But there's more. A value of 1.0 means that price has reached resistance at the upper band . As a result, %B shows values of 1.0 as overbought. Conversely, a drop to 0.0 represents an oversold level when prices reach potential support at the lower band. Chart 3 overlays %B on the S&P 500 over the last year. %B crossings above and below the middle (dashed) line, represent short-term buy and sell signals. Short-term overbought and oversold levels can be seen by the red and green lines. In other words, %B adds another trading dimension to Bollinger bands. At the moment, %B is pulling back from overbought territory, but remains above its zero line (keeping its uptrend intact). There's a third indicator that uses Bollinger bands to help determine market direction.

Chart 2

Chart 3

BOLLINGER BAND WIDTH ... Just above %B on the Indicator list, you'll find Bollinger Band Width (BB), which plots the difference between the two Bollinger bands. Here's why that's important. The distance between the two outer bands isn't constant. The distance expands and contracts depending on market volatility. When the bands are expanding and BB is rising, so is volatility. The result is usually lower stock prices. A falling BB means that the bands are contracting and represents lesser volatility, usually resulting in higher prices. Chart 4 overlays BB (black line) on a daily chart of the S&P 500 over the last year. Peaks in BB usually occur near market bottoms like last November and early March (green arrows). Sharp upturns in BB usually occur near market peaks like last May, September, and early January (red arrows). Chart 5 gives a closer look at the last six months. The good news at the moment is that BB is still dropping. The bad news is that the BB is dropping toward levels reached in January and February where it turned higher and prices weakened. Putting those two factors together leads me to conclude that the current rally may not have much further to run, but still remains intact. I started this message discussing the usefulness of daily Bollinger bands. You can get even more use out of them if you employ their two companion indicators.

Chart 4

Chart 5