Leader of the Bands: An Interview With John Bollinger

On Sept. 25, I had the opportunity to chat with John Bollinger, president of Bollinger Capital Management and the author of a new book, Bollinger on Bollinger Bands. We discussed his take on the current conditions in the market, and where he thinks we're headed in the future.

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Have you ever seen anything like this market before? It seems as if we're moving into a period where meaningful market moves will be few and far between.

Bollinger: Well, we've seen similar situations before. For example, from 1966 to 1982, the market went sideways for 16 years, and there were no more investors left by that stage of the game. They all eventually became frustrated, left the business and went on to seek other investments. Real assets became very popular -- real estate, gold, precious metals, oil drilling.

The only market participants left standing were "swing traders." But these swing traders were very different from the swing traders of today. They weren't interested in hourly, one-day, or even three-day moves. Instead, they were interested in the major moves seen on the daily or weekly charts. These swing traders wanted to take out the moves from $20 to $40, and then back to $32, and then back up to $50, and the stair-step decline thereafter. They wanted those big multiday or multiweek pieces. That type of trading has remained my discipline ever since I came into the business.

I think we'll probably be in this range for the balance of this decade, if not longer. We really arrived here in 1998, so we're already three years into the process. People are really stunned when you talk about something that might last for a decade, or even longer than that. But in that 16-year period -- or whatever it's going to be -- we'll build a base for the next phase of market activity.

It sounds like you're talking about market cycles.

Bollinger: Yes. From 1934 to 1950, we went sideways after the Crash for four presidential [terms]. The 16-year period from 1950 to 1966 -- again, four presidential terms -- was a huge bull market expansion phase. During the next 16-year period, from 1966 to 1982, there was a tremendous sideways phase where the averages went absolutely nowhere. And from 1982 to 1998, we had a very strong upside market. I think we're probably facing the other side of the game now, where reality will be allowed to catch up with stock prices, and everything is allowed to get back into gear, readjust and normalize.

I'm hesitant to be too attached to the 16-year concept, but clearly low volatility begets high volatility, and vice versa. But if you look at the charts, these spans seem to take a number of years to work themselves out. So I think it's pretty fair to assert that this decade is liable to be a sideways decade rather than a decade of major advance or major decline.

So this will likely be a "Decade of the Trader," rather than a "Decade of the Investor."

Bollinger: Yes. By the end of this cycle, the long-term investor will have left the market, won't read the financial pages and won't even know the name of his broker. The long-term investor will use his brokerage account more as a savings account -- using a money market account, maybe holding a few bonds, and perhaps have a few stocks that are close to him and he feels like he has some inside knowledge of the company. We'll be back to the day where the swing trader will be the hero -- those traders who look at the weekly charts with their relative strength lines. You know, the old classic situations. Those traders will do very, very well. This will be a grand environment for them.

Did you see this consolidation coming?

Bollinger: Well, I understood a couple of things, but I can't say that I really saw this consolidation coming. I understood that the real market had topped out in 1998. I understood that the rally out of the 1998 lows was a highly focused, very narrow rally involving only one group and its derivatives -- technology and Internet-related stocks. Anything that could be loosely tied to this group continued higher.

But this seemed to me like a feint because it was just too narrow to be significant. So I wasn't surprised to see the market top out. But I am surprised to see the extent of this decline. But I have no rational, analytical handle to apply to it. Every once in a while, you get a classically outlying event -- an event for which there is no precedent. And I think the current time frame is exactly that situation -- there just is no precedent to guide us.

You mentioned earlier that short-term trading was an inferior approach to buy-and-hold investing during the last bull market. Tell me more about that.

Bollinger: During a bull market, it's almost impossible to beat the S&P 500. The reason is because the S&P 500 is a cap-weighted index. One of the qualities of a cap-weighted index is that it is an incredibly efficient relative-strength allocation engine. And in a bull market, relative strength is the name of the game. Each day at the end of trading, stocks that have done well are awarded a few extra points of weight, and the stocks that have done poorly have their weighting reduced -- all with no execution costs.

So it's a rotation within the S&P world.

Bollinger: Correct. The S&P 500 is really the most efficient relative-strength portfolio that could be imagined. That's why, in a bull market such as 1982 to 1998, it was almost impossible to beat the S&P. It only likes the very strongest stuff, and it hates the weak stuff. It's merciless. Every day it weeds its garden, and every day it fertilizes its flowers. But in a sideways market such as the one we're in now, it's very easy to beat the S&P, because the S&P goes nowhere.

If you look at the Dow on an absolute basis, you'll notice that it is at roughly the same level as it was in 1998. Buying and holding has not been working. But on a relative basis, the Dow has made tremendous moves within its trading range, covering more total ground over the past three years than its peak value in 1998.

If you think that's interesting, groups have covered even more ground. So it has been far more profitable to focus on industry groups than on the averages themselves. And I really think that approach will extract the best returns going forward. Obviously, you need a market timing input to get some sense of whether the market is rising or falling. But I can see a very successful approach for the next seven to 10 years that focuses almost entirely on what groups to be in, and what groups to be out of. And then, just when people have come to totally believe in that method of trading, then it will be time for the next great bull market. And that is when you wish to revert to "buy-and-hold."

One last question: Are you seeing any sectors or industry groups that investors should look at right now?

Bollinger: Actually, the group structure is pretty devoid of information right now. Recently, I've seen something that I've never seen before. We keep track of the percentage of groups trading above their moving averages. We use the 10-, 50- and 200-day moving averages. Recently, all three of those measures, for the first time that I've ever seen, were beneath 2%. In fact, two of them on one day were beneath 1%. So right now, everything is dropping sharply and there is not that much information about potential leadership emerging from the current structure.

As the market tries to turn higher and we put a little bit of time behind us, we'll see how the leadership develops. But at this inflection point -- if we are indeed at the inflection point -- we'll have a problem finding the new leaders because the leaders into the lows are almost never the leaders out of the lows. With that said, the one trend that we've found interesting over the past week or 10 days is that the telecommunications sector seems to be trying to turn higher despite what's happening in the market. So this might be the beginning of some leadership from that sector, but it's way too early to tell.

Well, I really appreciate your insight and thank you for your time.

Bollinger: My pleasure.

Dan Fitzpatrick is a managing partner of Strathmore Capital, a private hedge fund in Englewood Cliffs, N.J. His column focuses on quantitative strategies for investment and trading. At the time of publication, Fitzpatrick held no positions in any stocks mentioned, though positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to [e-mail].

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