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Trading bands and indicators are both good tools, but when they are combined, the resultant approach to the markets becomes powerful. Band width, another indicator derived from Bollinger Bands, may also interest traders. It is the width of the bands expressed as a percent of the moving average. When the bands narrow drastically, a sharp expansion in volatility usually occurs in the very near future. For example, a drop in band width below 2% for the Standard & Poor's 500 has led to some spectacular moves. The market most often starts off in the wrong direction after the bands tighten prior to really getting under way, of which January 1991 is a good example (Figure 9).

AVOIDING MULTIPLE COUNTS

A cardinal rule for the successful use of technical analysis requires avoiding multicolinearity amid indicators. Multicolinearity is simply the multiple counting of the same information. The use of four different indicators all derived from the same series of closing prices to confirm each other is a perfect example.

So one indicator derived from closing prices, another from volume and the last from price range would provide a useful group of indicators. But combining RSI, moving average convergence/divergence (MACD) and rate of change (assuming all were derived from closing prices and used similar time spans) would not. Here are, however, three indicators to use with bands to generate buys and sells without running into problems. Amid indicators derived from price alone, RSI is a good choice. Closing prices

FIGURE 7: This indicator tells us where we are within the bands. Unlike stochastics, which are bounded by 0 and 100, %b can assume negative values and values above 100 when prices are outside of the bands. At 100 we are at the upper band at 0 we are at the lower band, above 100 we are above the upper bands and below 0 we are below the lower band. Also shown is the formula for band width.

FIGURE 8: Selecting the relative strength index (RSI) as our confirming indicator, we can observe that at A, the dollar index moved above the upper band while the RSl made a new high (confirmation). At B, the dollar index edged close to the upper band while the RSI failed to confirm (divergence). C constitutes a nonconfirmed retest of B.

FIGURE 9: When the band width indicator falls, the implication is that volatility is declining. At some point, the volatility returns. A drop in the band width to below 2% for the S&P 500 has led to some spectacular moves (such as January).

and volume combine to produce on-balance volume, another good choice. Finally, price range and volume combine to produce money flow, again a good choice. None is too highly colinear and thus together combine for a good grouping of technical tools. Many others could have been chosen as well: MACD could be substituted for RSI, for example.

The Commodity Channel Index (CCI) was an early choice to use with the bands, but, as it turned out, it was a poor one, as it tends to be colinear with the bands themselves in certain time frames. The bottom line is to compare price action within the bands to the action of an indicator you know well. For confirmation of signals, you can then compare the action of another indicator, as long as it is not colinear with the first.

John Bollinger, CFA, CMT, PO Box 3358, Manhattan Beach, CA 90266, (310) 545-0610, is president and founder of Bollinger Capital Management and publishes the monthly "Capital Growth Letter," a market letter for the average investor employing a technically driven asset allocation approach. He is also market analyst for CNBC/FNN