John Bollinger created the Bollinger Bands in the early 1980s. John believed volatility is dynamic and not static. He incorporated volatility into the Bollinger Bands to help determine whether prices are high or low on a relative basis.
The Bollinger Band Squeeze or the pinching of the two bands can be an effective technical trading strategy to identify a consolidation with decreasing volatility. This strategy does not have a bullish or bearish bias. It is a neutral trading strategy that alerts traders to an impending breakout or breakdown.
Bollinger Bands measures the volatility as well as the overbought or oversold levels. The objective is to alert the trader to whether the market is calm or volatile, denoted by the contraction and expansion of the top and bottom of the Bollinger Bands.
The Bollinger Band Squeeze garners attention from its practitioners when it contracts sharply. Since the bands denote dynamic and not static market volatility, the pinching of the bands alerts traders to a change in volatility ahead of a significant price move (up or down).
Bollinger Bands offers a trader a chart of the market’s high and low volatility points. Changes in volatility are easily identifiable because the market tends to alternate between high and low volatility, like the calm before the storm.
When the Bollinger Bands are far apart, volatility is high. When they are close together, volatility is low. A Bollinger Band Squeeze occurs when the bandwidth between the top and bottom of the Bollinger Bands reaches a six-month low level. The squeeze is likely when volatility nears pivotal turns, alternating from high volatility followed by low volatility and vice versa. From a timing perspective, a market that trades at a six-month low level of volatility via an extreme contraction in the bands often signals an impending explosive price breakout or breakdown.
Although the Bollinger Bands is an effective tool for measuring market volatilities, traders must also deploy other technical indicators and disciplines to confirm the breakout or breakdown. Only when there is a confirmed breakout or breakdown
Bollinger Bands appear to be pinching again, which signals a potentially significant price move soon. The Bollinger Band squeeze typically occurs when volatility falls to a low level, and the Bollinger Bands begin to narrow. Periods of low volatility are not sustainable and will revert to periods of high volatility. Volatility contracting or the pinching of the bands signals an impending significant price advance or decline.
Given the market collapse over the past six months, coupled with extreme bearish sentiment and market breadth readings, as well as an oversold condition, the above triggered another oversold rally on 6/17/22.
Although it has been 1-month since the technical bounce, the consolidation over the past month is constructive as it hints at the potential for a secondary rally that may sustain into the end of the summer to early fall.
The pinching of the Bollinger Bands and the potential for a short-squeeze bodes well for the next market rally. See the 7/19/22 blog entitled “Another Short-Squeeze Rally?” for further information.
Below is an analysis of the Bollinger Bands:
In the past month, the SPX Bollinger Bands have contracted, as evidenced by the top of the band (3,953.88) falling sharply and the bottom of the band (4,741,42) rising sharply. The pinching of the bands signals an impending price move.
The ability of SPX to clear pivotal initial resistance at 3,946-4,019 or the 6/28/22 high, 6/10/22 gap-down, the 38.2% retracement from 3/29-6/17/22) confirms the breakout and suggests +308.99 points or an SPX target at 4,255.
Interestingly, the breakout projection coincides with the 61.8% retracement (4,255) from Mar-Jun 2022. Under favorable market conditions, SPX can retest its 200-day ma (4,358) and Jan 2022 downtrend (4,407).
On the downside, the failure of SPX to confirm a breakout also warns of another downturn. Initial trading support rises to 3,875 (extension of the Apr 2022 downtrend breakout) and below this 3,796-3,817 (7/15/22 gap-up and 5/20/22 low), 3,721.5-3,734 (Jun 2022 uptrend and 7/14/22 low), and 3,636.87 (6/17/22 low).
Below 3,636.86, warns of the next SPX selloff toward 3,200-3,400.