Download PDF, Issue 26 - Swiss Futures and Options Association

Bollinger Bands
Let’s briefly review the concept of “Bollinger Bands”, made popular by the
market analyst John Bollinger. The Bollinger Bands can be seen as two nonlinear
lines (red and green) surrounding the weekly oil prices of Chart 4 and
the monthly gold prices on Chart 5.
To construct Bollinger Bands on a weekly chart, a central line (black) is
needed, which is a simple moving average of 20 weekly closes. The number
20 was optimized by John Bollinger. Further optimization is not forbidden,
but it can be noted that the period 20 is used as default in most charting
systems. Personally, I have selected 21 bars as my parameter value and used
it for both weekly and monthly bars. The Bollinger Bands are the two lines
either side of the central line on Chart 4, which create an envelope around
that central moving average to capture most of the price action. The statistical
concept of standard deviation (which measures the price dispersion
around the central line) is used to compute the Bollinger Bands, which illustrate
the historical price volatility of the last 21 weeks on a rolling basis.
The expert eye of a statistician would immediately notice that these bands
are removed from the central line by two times the standard deviation of
21 weeks.
It is important to note the different interpretation during a sideways price
evolution or during a well-established trend (upward or downward).
Chart 4 of the oil price allows us to differentiate nicely between these two
cases.
When prices are moving sideways, the upper Bollinger Band acts as a ceiling
on the price (in technical jargon called “resistance”). In this case, the sellers
in the market are stronger than the buyers, hence stopping the price from
rising. Similarly, the lower Bollinger Band signals a floor (“support”), where
buyers are stronger than sellers, leading to the end of a price decline.
In Chart 4, during the first half of 2001 (between $26 and $31 per barrel –
labeled 1, 2, 3), and from August to November 2003 (labeled 1, 2, 3, 4)
with a ceiling established near $33, the three lines are about flat and both
the upper and lower bands have had time to converge towards each other –
this is a typical sign of lower volatility.
On the contrary, as soon as a price trend emerges (as it is the case from
January 2004 onwards – labeled A to H), the upper band rises faster than
the central line, illustrating a typical increase in volatility. That upper band
will only slow down the advance of prices towards new highs on a temporary
basis. It is the central band that takes over from the lower band as a floor for
prices, which acts as support as the price steps higher. The description would
be symmetrically inverted in case of a declining price trend.
540 in early 2004, but this breakout was
not confirmed since the price pulled back
to trade for three months below 516, further
validating the neutral area below
516.
However, the recent test near 540 and
the recent slow rise above 516 both need
to be monitored. If the higher low in
May 2004 (near 480) and the recent
crossover of the two Slow Stochastic
lines near 25% are viewed as a buy signal
by the market, then there would be a
case for a violent rise. A sustained price
rise above 516–536 (staying for a while
near 540) would open a potential upside
target toward the key area of CHF
589–600, which was a significant chart
level from 1988 to 1994 (see the green
line). That said, this upside target would
be invalidated if we saw two monthly
closings below CHF 455, which is the
current level of the lower monthly
Bollinger Band (see text box on Bollinger
bands for further explanation).
Since the gold price in CHF has not
yet broken out above the top of this
range, we interpret this as a calming
influence on some of the extreme expectations
fearing an imminent comeback of
uncontrolled inflation. In short, no
immediate panic warranted.
Education
43
Bruno Estier is a global market analyst and founder of InvestorMade
in Geneva. He is current President of the
Swiss Association of Market Technicians, SAMT, and
serves on the board of directors of the International
Federation of Technical Analysts, IFTA, as Secretary and
former Chairman. Before joining Geneva private bank
Lombard, Odier & Cie, in 1994 as head Technical
Analysis, advising until 2003 the Portfolio Investment
Committee, Bruno had worked 12 years for JP Morgan in New York, Zurich
and Paris in the field of Market Research and Technical Analysis. A graduate
from the University of St Gallen and from the University of Chicago (GSB), he
can be reached at bruno.estier@dplanet.ch.
SWISS DERIVATIVES REVIEW 26 – NOVEMBER 2004