Technical analysis is the study of stock prices in an attempt to
forecast future price movements. The discipline teaches that all
relevant fundamental information is already embedded in the price,
therefore, by following price charts, one can increase the odds of
a successfulinvestment . There are hundreds of indicators and tools
a technical analyst can choose to perform a successful technical
analysis, but only one stands out as my favorite.
My favorite technical indicator
When evaluating a stock, I often begin withBollinger Bands . This
technical indicator is a way to visually measure volatility by
observing whether the price is high or low on a relative
Created by John Bollinger in the early 1980s, the bands are
built upon J.M. Hurst's and Marc Chaikin's trading band idea.
Simply described, trading bands are moving averages that envelope
price on a chart. John Bollinger took this simple concept and
developed a statistically-based standard for the bands, designed
easy-to-understand trading concepts around them and popularized
All readily available technical analysis software have
integrated Bollinger Bands. The standard design for Bollinger Bands
is a 20-period simple-moving average with an upper- and
lower-moving average, both two deviations away from the 20-period
simplemoving average . The upper and lower bands provide a visual
representation of how far the price has moved away from the average
(the 20-period simple-moving average).
How Bollinger Bands work
In their most basic form, Bollinger Bands work by indicating
whether a particular price is high or low on a relative basis. It's
easy to see whether the price is overextended on the upside or
downside by observing if the price bars are touching or piercing
either the upper or lower line.
The generally-accepted idea is to enter short if the upper line
is hit or pierced, in the belief that pricewill soon revert back to
themean . If the lower line is hit or pierced, then it is
considered a "buy' signal. It's important to remember that the
price can remain overextended in both directions for quite a long
time. Therefore, Bollinger Bands should not be used solely by
themselves as "buy" and "sell" signals.
They work best as confirmation tools for other indicators, such
as the fundamental picture. For example, if the price pierces the
upper band and other indicators signal bullishness, then the price
may continue higher, rather than reverting to the mean. However, if
the price pierces the upper band and the other indicators show
bearishness, then this is a clear short signal.
The Bollinger Band as abullish indicator
A good example of a bullish Bollinger Bandprice action is with the
so-called "sin stock" in the tobacco sector,
Altria Group Inc. (
. The price has solidly pierced the lower band, signaling it's
overextended on the downside and ready for a bounce higher.
Moreover, the company is diversifying away from its maligned
tobacco core and has increased its dividends year-after-year. Add
in an expectedrevenue increase of 5% in 2013 and the fact that Jim
Simon's RenTechhedge fund increased its holdings by 50% last
quarter, andshares have a clear bullish bias for the future.
A good example of a "sell" or short candidate through the
analysis of a Bollinger Band movement is with
Angie's List Inc. (Nasdaq: ANGI)
, a Web-based locating service for professionals. The stock is
exhibiting abearish Bollinger Band price action. The price piercing
the upper band combined with the fundamental picture of
increasingly negativenet income builds a strong bearish case for
Risks to Consider:
It's critical to remember Bollinger Bands are far from
foolproof. They need to be used in conjunction with fundamental and
sometimes other technical factors to optimize their effectiveness.
Never buy or sell a stock based solely on Bollinger Band signals as
stocks can remain overextended for long periods of time.
Action to Take -->
Bollinger Bands can help investors to pick and analyse price trends
in an easy manner. Given the technical and fundamental indicators
of both stocks mentioned above, I like Angie's List as a compelling
short and Altria as a solid long position.
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