1-2-3’S AND BOLLINGER BANDS
We’ve mentioned previously that Bollinger Bands perform a very
important function relative to ones ability to read price charts.
Bollinger Bands offer a visual presentation of the location of two
standard deviations by the price action. Statistically speaking, two
standard deviations will encompass 96.5% of all price action based
on a simple or exponential moving average of prices. If those prices
are the close, for example, then we can expect that 96.5% of all
closes will fall within the limits of the Bollinger Bands. Of all the
methods for finding market turning points, the Bollinger Bands have
proved to be the most successful, in that they are statistically reliable
in showing a trader where so-called overbought and oversold are
located. In fact, any software that will do separate Bollinger Bands,
one based upon a moving average of the lows and the other based
upon a moving average of the highs, will indeed provide an excellent
indicator of relative overbought and oversold. In the examples that
follow, we will be using the conventional Bollinger Bands set at 2
standard deviations based on a 20 bar simple moving average of the
closes.
However, indicators are seldom enough in and of themselves for
really good trading. Something else is needed to convict a trader of
the fact that a market turn has taken place and that prices are now
set to move in another direction, or at the very least cease moving in
the direction in which they have been unfolding.
That something else is the 1-2-3 formation. 1-2-3 highs that originate
at the upper Bollinger Band or the moving average line, and 1-2-3
lows that originate at the lower Bollinger Band or the moving average
line, provide some very excellent change-of-direction signals to the
alert trader.
Let’s look at some examples of this type of trading. It works well for
any time interval and in any market that is sufficiently dynamic to
swing from side to side while trending, or swing with sufficient
volatility within a Trading Range to cause there to be profitable 258
trading opportunities. In fact, if prices are not moving much within a
chosen time frame, then it is probably not worthwhile trading it at all.
In general, this occurs when the Bollinger Bands become relatively
flat.
