Bollinger Bands Squeeze
Updated: May 14, 2020
Bollinger Bands are popular trading bands that are comprised of centerline and two price channels or an upper band and a lower band. The centerline is a moving average (i.e., 20-period). The upper and lower band is based on a user-defined standard deviation (i.e., 2-standard deviation).
Standard deviation is based on the mathematical formula that measures historical volatility which depicts how the securities can vary from its true or normal equilibrium levels. By definition, a 2-standard deviation band will capture around 95% of the price action. This implies that the security will trade between the upper and lower bands. When it trades to the upper band, it is trading at overbought levels and will begin to decline. Conversely, when it trades to the lower band, it is oversold and will subsequently reverse direction by generating a rally.
The Bollinger Bands typically expand or contract as the price action becomes more volatile (expansion) or becomes less volatile (contraction). Periods of low volatility (bands contracting) are often followed by periods of high volatility (bands expanding). It is one of the more reliable trading bands because of the ability of the bands to “move” or to adjust themselves due to changing market conditions. When the upper and lower bands are extremely far apart, it can also signal the current trend is nearing an end and to expect a reversion back to its normal range.
One of the most useful applications of this trading band is the Bollinger Bands Squeeze strategy. It is a trading strategy that is specifically designed to find consolidations with decreasing volatility. An extreme contraction of the bands or a sharp narrowing of the bands suggests volatility is simply too low, at least from a historical perspective, and to expect a significant advance or decline in the immediate future.
Note that the contraction of the bands does not necessarily signal the specific direction of the next move. Rather, it only alerts traders and investors to prepare for an increase in volatility, and hence to expect an impulsive move is likely in the near horizon.
Enclosed are the daily Bollinger Band studies for key U.S. stock indexes including S&P Index (SPX), Dow Jones Industrial Average (INDU), and NASDAQ Composite Index (NDX).
S&P 500 Index (SPX)
The SPX Bollinger Bands is beginning to contract. The squeezing of the band hints of an impending major price move in SPX price. The width of the bands is currently at 198.26. At the current pace of the contraction it would imply this may lead to a retest the extreme lows recorded during Oct 2018 and Aug 2019. In the prior two SPX Bollinger Band squeezes this coincided with subsequent corrections in SPX. Note that the bottom of the Bollinger Band (2,737) resides near its 50-day ma (2,731) providing key initial support on pullbacks. On the other hand, a convincing move above the top of the band (2,934.32) and surpassing its 4/29/20 high (2,953.86) as well as its 200-day ma (3,002) also confirms a technical breakout and the next SPX rally.
Top of the band = 2,934.32, middle = 2,835.69, bottom = 2,736.06, and spread = 198.26.
Dow Jones Industrial Average (INDU)
The recent INDU rally is slowing as evidenced by the contraction of the Bollinger Bands. Although the contraction can continue (spread = 1,442.78) it is not sustainable at its current pace. The BB width is headed to a retest of its extreme lows corresponding to early-Mar 2020, Aug/Oct 2019, and Oct 2018. The squeeze in the bands is signaling an impending major move in the directional trend of INDU. The bottom of the bands (23,073) coinciding with the 50-day ma (23,145) provides key initial support. The top of the bands (25,516) and the 4/29/20 high (24,490) offers key initial resistance.
Top of the band = 24,515.98, middle = 23,794.60, bottom = 23,073.22, and spread = 1,442.78.
NASDAQ Composite Index (COMPQ)
NASDAQ Composite (COMPQ) continues to outperform its US counterparts. The contraction of the top and bottom of the bands or a squeeze is developing (spread = 905.66). However, unlike its listed counterparts, COMPQ is challenging the top of its Bollinger Bands (9,052.18). A convincing breakout above this resistance zone would signal the next rally to the 2/24/20 gap down (9,323-9,637), and above this to its 2/19/20 all-time high (9,8838.37). On the downside, the 200-day ma (8,439.5) as well as the middle of its band (8,599) provides key initial support. Below this warns of a decline toward the 50-day ma (8,124) and the bottom of its bands (8,146.5).
Top of band = 9,052.18, middle = 8,599.35, bottom = 8,146.52, and spread = 905.66.