Using 20 Day Bollinger Bands to Time Your Trades - Mike Swanson (08/29/2016)
Here is how to use the 20 day Bollinger Bands to time your trades.
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Transcript of above video:
Hi, this is Mike Swanson here. We're gonna talk today about how to use the 20-Day Bollinger Bands to time your trades, and understand what's going on with the markets, and more importantly, what's about to happen because that's really the key. Now, these are some of the most popular technical indicators used for technical analysis, for analyzing the trends of a stock, an ETF, or the general stock market. And we're gonna do all of that.
Now, these popular bands were invented by John Bollinger in the 1980s. There's a picture of John right there, in fact. Now, what are these bands and why are they so popular? Well, take a look at this chart. This is TLT, the 20-year treasury bond ETF.
The bands in this chart are pink and they're the 20-day bands I'm using in this instance, they are the default settings if you use stock charts, and many other popular charting software. Some of them use 15, but most use 20. I tend to use the 20 myself and the 200-day for analyzing the long-term trends, that's another topic. Let's stick with the building blocks of understanding how they work with the 20-day trend.
So, what the bands are is they use the 20-day moving average. You may... If you look very carefully, that's the dotted line in pink here, and they have a line above the 20-day moving average and a line below the 20-day moving average. What those lines are, are standard deviations above and below using a simple percentage calculation. Now, what this does is, it gives you an idea of the price volatility.
The price usually is contained within these standard deviation levels. Rarely does the price go through one of these levels and if it does, it comes back down most of the time. So some people use this indicator as an entry/exit point.
If the price is hitting the lower band, they'll try to buy, sell at the higher band, jump in and out. That's a very short-term orientated type of strategy, I don't really use it for that myself. I use it to understand a different thing, which I'm gonna explain in this video, this presentation. So, what is that I use it for?
What's key is the upper and lower bands, they are measuring the standard deviation of the price, but they move closer and farther apart by how that price itself is becoming less volatile or more volatile and that's a key concept, which we're going to look again, because this can help you understand if a large price movement is to come.
What tends to happen is price volatility shrinks when the band shrinks. And that's a situation that happens often before a big move is about to happen. That helps you get ahead of a big move or prepare for a big move. So, the Bollinger Band width when it becomes very narrow, suggests that that volatility compression is gonna end and the bands are gonna then start to go wide apart. Doesn't tell you what direction that's gonna happen, but it tells you that it's coming, which can be just as important to prepare yourself for it.
So, if you look at this chart closely, you can see that the Bollinger Band width indicator which is measuring the width between the two bands, when it gets low, that means the bands are being compressed. And I've highlighted on this chart, key moments on this TLT ETF where that's happened. And what has immediately happened afterwards is you would have a move out of the bands that would make the bands start to compress and often, this TLT would ride up for nice trend move. So the bands can be used for swing trading situations that last more than just a few hours, but days, sometimes weeks. You can see how this happened in January and I've marked that with the arrow on this chart. It also happened in March, that move only lasted few weeks. But the move in January was a big move that took TLT in a breakout situation above 132.5 to 142.5. Same thing happened in the beginning of 2016, which I've highlighted, TLT went from 122.5 to 132.5.
In November there was a breakdown, that happened in November 2015, a very short lived one and a short lived move in September before.
But this is a much more reliable way to trade than simply trying to buy when something hits the lower band and sell when it's goes to upper band.
Using the 20-day Bollinger Bands must be incorporated with looking at the big trend in the Market. To do that, I use Stage Analysis.
Are we in a Stage 2 Market, Stage 3 topping market, Stage 4 bear market or, Stage 1? In Stage 2, you wanna be looking for consolidation entry points to buy or dips to buy. That's how you do in a bull market.
In bear markets, you want to sell rallies, and so forth.
In Stage 3 you're looking for a transition from... That's gonna lead to a big drop. So, let's take a look at how this can be used with the HUI Gold BUGS index, which tracks the gold stocks sector, because this has been in a powerful up trend for much of this year and these 20-day Bollinger Bands could have been used to spot the end of consolidation periods and immediate up thrusts to time entry points in this market. You can see how that could've worked in April, you can see how that could work in July.
However, right now, in August, the bands were signaling that a move was coming, and this time it was down. So that suggests that the big momentum rally from February to August has actually come to an end and we're in some sort of pause situation. Interestingly enough, from July to January, July 2015, January 2016, there's a Stage 1 base going on, so you can see how the bands signaled little drops that weren't sustainable, that told you something was changing. In 2015 though, before the bottom, of that August, we were in a bear market, which the bands would signal dumps were coming, and they did. And that's what was going on for the preceding couple years.
So, when you put the bands in context with the stage analysis, what the big trend is, then you can use them to create entry points in that trend and spot the end of consolidation periods in bull markets that proceed big moves up.
So what's going on with the stock market right now?
The past couple years have been very interesting with the 20-Day Bollinger Bands 'cause they have not signaled big rallies up, they signaled immediate drops, which actually turned into fast drops, then moves back up, which didn't really lead anywhere until finally the market broke out in July, but really hasn't yet gone anywhere.
Well, what does this mean? Well, let's look at August 2015, the 20-Day Bollinger Bands compressed, they became very narrow and the market dumped, it broke it's three-day moving average and had the flash crash, of, I think it was August 25, 2015. Horrible situation, but the market bounced, went sideways and rallied back up. And then in January, the same thing happened, the bands compressed, the market dumped. But then in February and March, it had a similar bottom as it did from August, October 2015, rallied back up. What does all this mean?
Well, it means that, I think that all represents a giant Stage 3 topping process because in bull markets, such compression leads to big rallies as you saw with the gold stocks, the first year, that bull market there. Instead, we had dumps in the context of a Stage 3 top. Now, finally, it took three years to happen, but this July SMP500 went through the 21, 25 level and stayed above it for more than a few days, but it hasn't really gone anywhere, yet. And the volume has died out this August, the volatility has died out this August, to the point similar to where it was in August 2015, except this time, it hasn't immediately dropped yet, which in itself is very interesting.
This is something that is a very rare situation with these 20-Day Bollinger Bands. In fact, you've got to go all the way back to 1993, that's over 23 years on the stock market to find them this close together.
So it's a very rare situation we're in right now. So, we're in a holding pattern where support is really Friday's low of 2160, resistance is the upper band, really 2200 let's say. And we're drifting. But a close above that upper band or below the lower band will create the next move in the context of what I believe is a Stage 3 top and there's other reasons I think that that's the case, besides just what I'm talking about here, I'd have to go into deeper in more videos. But in the context of that, a break of 2160, sometime, let's say, in September, will lead another sustainable drop as we saw last fall, last January, back down to the moving averages, at the least, and then we'll have to go from there, but it could be a very significant move. So, right now, the Bollinger Bands are telling us that we're in a very unusual situation, and they're very useful to use to understand what's happening. That's why we pay attention to them and so forth. And I'll be keeping you up to date in videos what's going on.
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