Envelopes and Methods of Price Containment
during a strong price excursion. Rapid price moves will cause the bands to
diverge and a period of low volatility will cause it to squeeze, that is, the up-
per and lower bands converge. The squeeze is normally a precursor to a strong
price move. Many traders will wait for a squeeze before trying to catch the
subsequent move.
Though a close beyond the bands is a breakout trigger, many traders employ
either the standard reversal entry or the reversal entry breakout approach with
regard to trading the bands.
One interesting pattern is the double top with only the second peak located
within the Bollinger Bands. This pattern is considered bearish and traders should
seek price confirmation before participating, should a downside move subse-
quently unfold. (Similar confirmation is advised for a double bottom pattern with
only the second trough located within the Bollinger Bands—a bullish formation.)
Associated with the Bollinger overlays are two oscillators that help chartists
gauge potential reversals and continuations in price while using the bands. The
first oscillator is the Bollinger bandwidth, which simply tracks the percentage
difference between the lower and upper bands. When the Bollinger bandwidth
indicator declines and remains at lower readings, it is a warning of a potential
volatility breakout. It helps to identify the squeeze formation.
The second is the Percent B indicator that tracks the position of price relative
to the bands. A reading of one corresponds to price being at the upper band, while
a reading of zero corresponds to price being at the lower band. The readings willFigure 12.13 Comparing Fixed Percentage Bands via Different Chart Scaling on the
Daily Chart of Goggle Inc.
Courtesy of Stockcharts.com