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ANSWERING THE QUESTIONS

Trading bands answer the question whether prices are high or low on a relative basis. The matter actually centers on the phrase "a relative basis." Trading bands do not give absolute buy and sell signals simply by having been touched; rather they provide a framework within which price may be related to indicators. Some older work stated that deviation from a trend as measured by standard deviation from a moving average was used to determine extreme overbought and oversold states. But I recommend the use of trading bands as the generation of buy, sell and continuation signals through the comparison of an additional indicator to the action of price within the bands.

Bollinger Bands can be applied to virtually any market or security. For all markets and issues, I would use a 20-day calculation period as a starting point and only stray from it when the circumstances compel me to do so.

If price tags the upper band and indicator action confirms it, no sell signal is generated. On the other hand, if price tags the upper band and indicator action does not confirm (that is, it diverges), we have a sell signal. The first situation is not a sell signal; instead, it is a continuation signal if a buy signal was in effect.

It is also possible to generate signals from price action within the bands alone. A top (chart formation) formed outside the bands followed by a second top inside the bands constitutes a sell signal. There is no requirement for the second top's position relative to the first top, only relative to the bands. This often helps in spotting tops where the second push goes to a nominal new high. Of course, the converse is true for lows.

INTRODUCING %B AND BAND WIDTH

An indicator derived from Bollinger Bands that I call %b can be of great help, using the same formula that George Lane used for stochastics. The indicator %b 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. See Figure 7 for the exact formula.

Indicator %b lets us compare price action to indicator action. On a big push down, suppose we get to -20 for %b and 35 for relative strength index (RSI). On the next push down to slightly lower price levels (after a rally), %b only falls to 10, while RSI stops at 40. We get a buy signal caused by price action within the bands. (The first low came outside of the bands, while the second low was made inside the bands.) The buy signal is confirmed by RSI, as it did not make a new low, thus giving us a confirmed buy signal.