The volatility squeeze is a potentially profitable setup but also can be prone to dangerous whip-saw price action. A long entry requires a strong breakout or upper candle close above resistance, and a short entry requires an equally strong breakdown or lower candle close below support. A disciplined trading plan is required, utilizing close sell- or buy-to-cover stops.

Bollinger bands are based on the standard deviation of a stock price around an average and are a measure of volatility. Bandwidth narrows when volatility falls to a low level and is a sign that a "squeeze" play may be setting up. The theory behind the squeeze is that periods of low volatility are followed by periods of high volatility, and this rapid resolution of price consolidation can signal the start of a significant advance or decline.

These five stocks in the biotechnology space, a sector known for periods of volatility, are being squeezed and look ready for reactive moves.

Acadia Pharmaceuticals

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Acadia Pharmaceuticals (ACAD) - Get Report has been trading in a triangle pattern since June, with the downtrend line of the triangle pattern currently being reinforced by the 50-day moving average and with the 200-day average tracking along the horizontal support line. The Bollinger bandwidth indicator at the top of the chart shows band contraction at its lowest level since the beginning of the year, just prior to a sharp mover lower. Momentum is flat, with the relative strength index moving sideways, above its 21-period average but below its center line, and volume is weak. Chaikin money flow has been improving over the last month.

BioMarin Pharmaceutical

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There is a similar triangle-like formation on the BioMarin Pharmaceutical (BMRN) - Get Report chart, with the rising 50-day moving average following the support line and resistance in the $97.75 area, the intersection of the downtrend line and a small horizontal resistance line. The flat moving average convergence/divergence reading reflects the Bollinger bandwidth compression, as momentum is constrained by the contracting price range. Volume is low, but money flow is positive, and it looks like the stock is under some accumulation.

Cempra

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Cempra (CEMP) has formed a formed a rounded or saucer bottom over the last six months. The stock moved above resistance in early August and then successfully retested that level at the end of the month. It has made a higher low since then and is currently retesting horizontal resistance in the $23.50 area. The stochastic oscillator is above its center line, volume jumped in Tuesday's session, and the accumulation/distribution line crossed above its 21-period signal average.

Illumina

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The bands are very tight on the Illumina (ILMN) - Get Report chart, as the stock has made a rounded top above static support in the $165 area. Stochastics are bouncing off their oversold level, but Chaikin money flow is negative, a conflicting but not unusual technical condition associated with the squeeze setup. It is pure price action that reveals the direction of breakout.

Neurocrine Biosciences

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There is a flat level of resistance on the Neurocrine Biosciences (NBIX) - Get Report chart in the $52.50 area, above a rising support line off the lows since March of this year. The action has formed a large triangle and compressed price as it nears its apex. Chaikin money flow is slightly above its center line and the relative strength index is holding above its center line.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.