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.
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 |
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 |
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 % |
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.)
Figure 3 Bollinger Bands system |
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