In this example Microsoft is charted using 20 day Bollinger bands at 2 standard deviations.
Contracting bands warn that the market is about to trend: the bands first converge into a narrow
neck, followed by a sharp price movement. The first breakout is often a false move, preceding a
strong trend in the opposite direction. A contracting range [C] is evident in June 1998: the bands
converge to a width of $2, followed by a breakout in July to a new high.
A move that starts at one band normally carries through to the other, in a ranging market. A move
Outside the band indicates that the trend is strong and likely to continue – unless price quickly
Reverses. Note the quick reversal [QR] in early August. A trend that hugs one band signals that
the trend is strong and likely to continue. Wait for divergence on a Momentum Indicator to signal
the end of a trend.
In this example, 20 day Bollinger Bands at 2 standard deviations and 10 day Rate of Change.
1. Go short [S] – bearish divergence on ROC.
2. Contracting Bollinger Bands [C] warn of increased volatility. This begins with a false rally
(note the ROC triple divergence) followed by a sharp fall.
3. Go long [L] – price hugs the lower band, followed by a bullish divergence on ROC.
4. Go short [S] – price hugs the upper band, followed by a bearish divergence on ROC.