S&P 500 TESTING ITS FEBRUARY HIGH -- USING BOLLINGER BANDS FOR GUIDANCE
S&P 500 IS TESTING ITS FEBRUARY HIGH... The most important test going on at the moment is the S&P 500 challenging its February high. Its highest intra-day value shown in Chart 1 is 3393.52. The SPX closing high for February was 3386.15. Although the major trend for the SPX is still higher, retests of a prominent peak often produce some profit-taking which can take the shape of a market pullback or a period of consolidation. The 14-day RSI line in the upper box is near overbought territory at 70. While daily MACD lines in the middle box are positive but showing some negative divergence. So there may be some reason for added caution at this point. But there's another indicator that may shed more light on the market's current condition. I'm referring to Bollinger bands.
BOLLINGER BANDS ON THE SPX... Chart 2 plots daily Bollinger bands over the S&P 500. The middle dashed line is the 20-day moving average which is the time span generally applied to the bands. The two outer bands are plotted two standard deviations above and below the dashed 20-day line. The current trend is positive because the price is above the 20-day average. Prices usually trend between the upper band and the 20-day line during an uptrend. The upper band can also sometimes act as a resistance line. And prices will sometimes pull back from that upper line like they did in early June and again in late July. In the first instance, prices fell all the way to the lower band, while in the second prices bounced off the 20-day line. That shows one of the advantages of Bollinger bands which is that they offer potential support levels during a market pullback. The first level of support is usually the 20-day average which currently sits at 3295; and the second is the lower band which currently sits at 3187. The fact that the SPX is now testing an important resistance level at its February high while in a somewhat stretched condition may increase the odds of some type of pullback to one of the lower lines. But there's more to come. Two indicators based on the bands can also be helpful in determining when the price is overbought and when volatility may be increasing.
BOLLINGER BANDS %B... The line in the upper part of Chart 3 plots the Bollinger %B which measures percentage moves above and below the middle zero line. And it helps to identify overbought conditions. In this version, the middle zero line is the 20-day average which acts as a potential support line. Moves over 1.00 can mark potential overbought conditions. Those overbought readings happen when price exceed the upper band which happened briefly last week. That in itself doesn't signal a market pullback. But it takes on more importance when the market is in an overbought condition and up against important resistance which it is now. Fortunately, there's another way to use the bands to help identify potential market tops. And that's with Bollinger Band Width.
BOLLINGER BAND WIDTH MEASURES VOLATILITY... The upper line in Chart 4 plots Bollinger Band Width which measures the distance between the two outer Bollinger bands. As a rule, a low value in the BB width suggests a safer market condition of lower volatility which is the case at present. An upward spike in the width line, however, would signal greater volatility which is usually associated with falling prices. The last time that happened was late February when the S&P 500 last peaked (red circle). The peak in the upper line in late March signaled a market bottom (down arrow). The current value of the line is 6.6 which is still relatively low. But it bears watching. Any sudden spike would be a signal that a market pullback could be starting. If that were to happen, we'd then look to the 20-day average or lower Bollinger band for potential support levels.
WHO INVENTED BOLLINGER BANDS?...Bollinger bands can be found under Overlays on your chart; while the two other versions can be found under Indicators. As their name implies, Bollinger bands were invented by John Bollinger and are very popular with technical traders. Given the important test taking place in the S&P 500, they may be worth paying closer attention to. And that includes the two other versions of the bands shown above. Bollinger bands also be used on weekly and monthly charts for longer-term perspective. In both cases, the default value of 20 weeks or 20 months remains the same. They can also be used in intra-day charts for short-term analysis.
