Novice Traders' Notebook  |  MAR 1999

Bollinger Bands by Stuart Evens

Bollinger Bands by Stuart P. Evens This indicator combines popular technical methods — moving averages, support/resistance, and envelopes — with statistical analysis to create a powerful technical analysis tool. Bollinger Bands, used in combination with the relative strength index (RSI) to analyze a market, enables us to develop a method to enter and exit trades and review the historical results. On a day-to-day basis, markets trade in a volatile fashion around the trend. To better see the trend, traders use moving averages to filter the price action. This way, traders can gather important information regarding how the market is trading. For example, after a sharp rise or fall in the trend, the market may consolidate, trading in a narrow fashion and crisscrossing above and below the moving average. To better monitor this behavior, traders use price channels, which are designed to encompass the trading activity around the trend. Bollinger Bands are one such technical tool. Before we discuss Bollinger Bands, however, let’s have a quick look at some other methods that traders have used. Some technicians use moving averages with support and resistance lines to anticipate the price action of a stock. Upper resistance and lower support lines are first drawn and then extrapolated to form channels within which the trader expects prices to be contained. Some traders draw straight lines connecting either tops or bottoms of prices to identify the upper or lower price extremes, respectively, and then add parallel lines to define the channel within which the prices should move. As long as prices do not move out of this channel, the trader can be reasonably confident that prices are moving as expected.

by Stuart Evens