Playing a Pullback Using Bollinger Bands

In these uncertain times, any trading edge you can get is worth having. Numerous market watchers continue to caution that a retest of the lows set on Sept. 21 is inevitable. Whether these lows can hold should determine whether the bears have gone into hibernation or if there is more ugliness ahead. One technical indicator that will give you an edge if we do indeed retest these lows is Bollinger Bands.

John Bollinger, author of the new book Bollinger on Bollinger Bands, invented this indicator. These bands are drawn above and below the price structure on a chart and are designed to contain approximately 90% of all price action.

Calculating Bollinger Bands

A 20-period simple moving average (20 is the default length, but it can be adjusted to suit your trading style) is known as the "middle band." The upper and lower bands measure the volatility of the chart by applying a standard deviation formula to the same data as were used for the middle band. You can refer to Bollinger's book for the precise formula. Here, it is enough to say that the upper and lower bands are each two standard deviations from the middle band, and they expand on increased volatility and contract on decreasing volatility.

The beauty of Bollinger Bands is that they are a measure of "relative" price levels, rather than absolute levels. For example, if a closing price of $10 were below the lower band, $10 would be considered lower than a closing price of $9 that closed higher than the lower band. While $10 is higher than $9 on an absolute basis, it is lower on a relative basis.

Using Bollinger Bands

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