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Technical Stock-Picking: How to Bet on Bollinger Bands

Here's a look at how to spot and ride price trends.

This technical-analysis-based assignment was written by Stockpickr member Ira Krakow.

In "

Technical Stock-Picking: Get to Know the Moving Average," you can see how

moving averages can help you "time" your stock buy or sell decision. But stock

technicians don't rely on one arrow in their quiver. This assignment will look at how technicians use Bollinger Bands to spot and ride price trends.

3 Stocks I Saw On TV (Feb. 1)

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If you watch

Dan Fitzpatrick's "3 Stocks I Saw On TV" videos on

TheStreet.com TV

or read his technical commentary on

RealMoney

, then you would know that he's a big fan of Bollinger Bands. Here's why.

A Look at Altria's Chart

The screenshot below is from Fitzpatrick's Jan. 31 video. It's of a weekly three-year chart of

Altria

(MO) - Get Altria Group Inc Report

, with its Bollinger Bands turned on.

There are three lines (or bands) that overlay the candlestick chart. The Bollinger Bands (developed by John Bollinger) are based on the moving average of the stock (the middle band). In this screenshot, the middle band is the 20-day moving average. The high and low boundaries are then calculated using a mathematical measure of

volatility called the

standard deviation.

Typically, two sets of standard deviations are used: one with the band above the moving average and one with the band below the moving average. Don't worry about the actual formula. Your charting software will calculate and draw the bands for you. (If you use Yahoo! Finance's chart tool, then under "Technical Indicators," select "Bollinger Bands.")

The Bollinger Bands give you an idea of the stock's price support and resistance levels, as well as how wide a price range the stock is expected to trade in. If the difference between the upper and lower band is expanding, the stock is breaking out of its

trading range (either high or low). You can see this type of upward trend in Altria's October-to-December ("OND")

quarter in 2007 (see where the hand icon is pointing in the screenshot).

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Notice that the Bollinger Bands expanded during the July-to-September ("JAS") quarter of 2007. This indicates that the stock was consistently trading at a higher price. You might want to ride a trend like this all the way up until the bands start to narrow. The narrowing of the bands indicates slowing price growth. If the bands are narrowing and the price is decreasing, it may be time to sell because the upward trend has played out.

3 Stocks I Saw On TV (Jan. 31, featuring Altria)

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Using Bollinger Bands to Avoid Big Losses

Bollinger Bands can also be used for stocks in a down trend. Look at a recent one-year chart for

Citigroup

(C) - Get Citigroup Inc. Report

:

March through October 2007, Citigroup was generally trading in a narrow range. Suddenly, the bands widened -- indicating increased volatility -- and the price dropped within a month to the low 30s, continuing into the high 20s. A shareholder of Citi who was an attentive chart-reader would have spotted a sell signal in late October -- as the bands widened -- and would have averted a large loss.

Your Bollinger Bands Assignment

This week, your homework assignment is to find the exact time to buy or sell a stock based on its Bollinger Bands.

Step 1.

On

Stockpickr, create a portfolio called "Bollinger Band Trades:

Your Stockpickr Username." (To create a portfolio on Stockpickr, you'll need to first log-in. If you're currently not a Stockpickr member, you can register at

www.stockpickr.com/register.)

Step 2.

Pick five stocks you are interested in buying or selling. Using your favorite charting software (like

Yahoo! Finance Charts), plot the stock price and its Bollinger Bands. Plot an intraday or one-day chart of your stocks, with intervals as small as one minute during the day.

Where is each stock trading relative to its Bollinger Bands? Did the price break above or below them?

Use the bands to pick the right time to buy or sell. Check out

volume as well -- a move on heavier than average volume makes the buy or sell signal even stronger (see "

Technical Stock-Picking: How to Trade Off of a Stock Chart"). Document the times and prices for your trades in Stockpickr's "Reason?" box.

Step 3.

Repeat Step 2 for the next three trading days, or until you feel comfortable trading real money (see "

Making the Transition from Investor to Trader").

By combining technical trading tools like Bollinger Bands and moving averages, and only acting when you are confident in your decision, you should improve your trading performance.

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