John Bollinger created the Bollinger Bands in the early 1980s. John believed volatility is dynamic and not static. He incorporated volatility into the trading 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 devastating breakdown.
Bollinger Bands pinched late last week as the two bands contracted sharply, as evidenced by the top of the band (currently at 4,110.5) falling sharply and the bottom of the band (currently at 3,839.5) rising sharply.
The pinching of the bands signals the potential for a short-term significant price move. The Bollinger Band squeeze typically occurs when volatility falls to a low level and the Bollinger Bands contract.
Periods of low volatility are not sustainable and will revert to periods of high volatility. Volatility contracting or the pinching of the bands precedes an impending significant price advance or decline.
The failure of the SPX Index to surpass critical resistance at 4,100/96 (12/13/22 high) triggered another round of selling as recession fears and the Federal Reserve’s continued hawkish stance to keep interest rates high into the new year spooked investors.
Volume exploded on 12/16/22 to one of the highest volume days this year soon after SPX broke below initial support near 3,906.5-3,920 (bottom of 1-month technical base), the 50-day ma (currently at 3,867), and the bottom (currently at 3,839.5) of its Bollinger Bands.
The four days of selling have pushed SPX into a short-term oversold condition. Although a short-term technical bounce can develop, given the failure of SPX to reverse the Jan 2022 primary downtrend and the recent technical breakdowns, any oversold rally will be brief as the dominant 1-year bear trend is likely to prevail.
On the downside, violation of the 3,906.5-3,920 confirms a 1-month technical base breakout and warns of a decline of 194.42 points or downside risks to 3,712 or near pivotal support at 3,698-3,724 (Jul and Nov 2022 lows, the 61.8% retracement from 10/13-12/13/22 rally, and the 1-mo breakdown target). The RSI indicator, currently at 39.59, should be trading near 30 by this time, prompting a technical bounce.
Initial trading support falls to 3,867 (50-day ma) and above this 3,920-3,966 (11/17/22 low, the extension of the 1-mo breakdown, and the 12/15/22 gap-down), 4,024.5-4,067 (200-day ma and Jan 2022 downtrend), 4,100-4,119 (the top of the Bollinger Bands, and the Sept, Nov, and Dec 2022 highs), 4,177.5-4,219 (8/22/22 gap-down and Jun 2022 high), and 4,325.28 (8/16/22 reaction high).
Failure to maintain support at 3,698-3,724 signals a weak market environment, prompting a decline toward 3,584-3,637 (Jun and Sept 2022 lows) and below this 3,491.58 (10/13/22 reaction low). Violation here signals a significant SPX sell-off toward 3,172-3,332 (bottom of the Jan/Feb 2022 downtrend channel and the critical 61.8% retracement from the Mar 2020-Jan 2022 rally).