Bollinger Bands System

The basic idea for using Bollinger bands is that when a stock hits the upper band, it is usually overbought so you should short, and when a stock hits the lower band, it is usually oversold, so you should buy. The rationale is that price tends to revert to its moving average.
Buy when a stock hits the lower band using a 20-day moving average
and 2 standard deviations.

Sell when a stock returns to its moving average.
Bollinger Bands System
figure 1 Bollinger Bands System
On July 7, 2001, CHKP (shown in Figure 2) gapped down and proceeded to hit its lower Bollinger Band at 40.45. The system held the position until July 27 at 42.69 for a 5.51 percent profit. (See Table 1 for results.)
Bollinger Bands System results
Bollinger Bands System results
The basic idea holds up and delivers a fairly consistent return with a high probability. There are several twists that I do on the basic system to improve both the odds of success and the percent return per trade. For one thing, I do not like to wait for the stock to return to its moving average.
Even if a company is in big trouble, even going bankrupt (and see Technique 3 on bankruptcies for an example of what I am about to say), stocks do not move in a straight line. The faster the spike down, the more likely the stock is to do a quick bounce up. However, if the company is truly in trouble, over time the stock will do its little spike up and then drift down, bringing the moving average, and the potential for profit, down with it.

Not only am I interested in if the stock simply touches the Bollinger band, but if it decisively breaks through it, which introduces the concept of “per- cent b.” Percent b (%b) is the percent level the stock price is at relative to its bands. If the stock is dead center between the bands, then the %b = 50.
Bollinger Bands System
Bollinger Bands System
If the stock is touching the upper band, then the %b is 100, and if it is below the lower band, then the %b is negative. The following formula is used to calculate %b:
Formula Bollinger Bands %
Formula Bollinger Bands %
Which all leads to the following:
Buy when %b is less than –20 using Bollinger Bands on the 10-day moving average with 1.5 standard deviations and hold at least until the close of that day even if profit target is hit.
Sell when either a 15 percent profit target is hit or four days go by, whichever comes first. With this system, we are using the 10-day moving average to get quicker and sharper spikes. We use a –20 %b to make sure it is a decisive break of the bands. And if we don’t get our target within four days, then we are run like hell out of the trade.
Example: SEBL, 8/31/98
August 31, 1998. The markets had been in turmoil all summer, culminating in the Long Term Capital Crisis. Panic had set in and everyone was worried the party was over. After nine down days in a row, during four of which the lower Bollinger Band was broken through, the stock price finally hit our buy target at 4.81 on August 31. The next day it bounced, hitting a 15 percent target at 5.54 (see Figure 3).
Example: BRCD, 4/14/2000 April 14, 2000, was not a pleasant day to be long tech stocks. In fact, it seemed like the world might quite possibly end. At the time I was working at 44 Wall Street, and when I left the building that evening pedestrians were jokingly being warned to stay away from the sidewalks just in case people were jumping out of buildings. Nevertheless, despite the pain, it was certainly an important day to be buying short-term moves in stocks. As shown in Figure 4, on that day, BRCD triggered a buy signal at 46.42. It started to make a comeback on Monday the 17th and finally hit the 15 percent profit target on the 18th at 53.38. (See results in Table2.)
Bollinger Bands system
Figure 3 Bollinger Bands system


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