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Greetings, Pro-fundity team members -
11-14-03

At the bottom of the Guidepost, a full listing of this weeks picks are shown, in addition to the Charts via the Pick-link.

As a benefit of membership, you have access to all Guideposts (including Archived GP's) and Picks. If you miss a week or two for whatever reason, you will be able to go into the Historical Guidepost link to catch up with both the weekly guidepost and the 30 picks made for the week.

Greetings, fellow Pro-fundity team members.

In this lesson we will continue our study of Bollinger Bands, going through several chart examples to heighten our understanding.

Bollinger Bands

1. Each week as we prepare the Main, Breakout, and Quick picks for the page offering, scans are utliized to reduce candidate stocks from over 7000 to around 400. This series of filters provides the right price, the right volume, and the right fundamentals to meet our system criteria. It also kicks out any picks published during the past six weeks, making each week a refreshing new batch. Next, the excitement of chart reading takes over, where each stock in the short list (400+) is scrutinized for technical character. This is the highlight of the week, as we attempt to read messages contained in the chart patterns. In this lesson we will share some of that excitement, helping you listen to the messages. You should delight in laboring through this step in the process, and really enjoy looking at dozens (hundreds) of charts. In this lesson, we use Bollinger Bands to listen.

2. Following are several chart examples showing how Bollinger Bands can help the pick process. We will also see how Candlestick charts can help us understand where a chart pattern is likely to go. These examples rely on nothing but the Bollinger Bands around the price pattern. In the first example, AMEV is a pick chosen on 10/24/03 with its resulting price chart one week later, 10/31/03. The black marker in the right segment is placed on the day of the pick (10/24/03) with five bars for the following week. The first segment shows a positive upward trend, but notice how the green 20-day moving average (the base for the BB’s) provides support as the price moves up. This example is helpful as we guess where the price will go next. We did not expect the price to fall below its moving average, confirmed by the resulting five bars following the pick.
   
   Fig. 1 AMEV, a 10/24/03 pick, showing the MA as support in the up-trend.

3. Now, repeat this chart pattern in Candlestick format. Look carefully, notice any difference? Both charts contain exactly the same information. So, why the interest in Candles? With practice and experience, it is easier to see subtle messages in Candlestick patterns. They provide a more “trader-friendly” version of the data. We’ll include candle discussions as we move through the course.
   
   Fig. 2. Candlestick version of the AMEV price chart.

4. In the previous example, notice the cyclical nature of the BB’s, that is, how the volatility cycles. The width of the Bollinger Bands (vertical distance between the high and low) shows how low volatility leads to high volatility, and vice versa. This cyclical nature of volatility continues, as price moves up, down, or sideways. Other BB “fingerprints” reoccur with remarkable consistency. For example, in an up-trend price can walk up the upper Bollinger Band as seen in Fig. 2 above in the September time frame. It not only “tags” (touches) the upper band but hugs it for some length of time. The same is true for down-trends, where the price can hug the lower band for a while on its descent.

5. What does that mean to us as traders? Remember how Bollinger Bands replaced trading envelopes when they were introduced in the last lesson. Trading envelopes provide sell signals at the top, buy signals at the bottom. This similarity has created the myth that upper band tags are sell signals, lower band tags are buys on Bollinger Bands. Not so! In fact, tags of bands or even closes outside the bands can be continuation signals rather than reversals. Tags are just tags, by themselves, not signals. Here are some important BB rules:
   
   • Sharp price changes tend to occur after the band tighten, as volatility lessens. This is the same point made earlier regarding how low volatility breeds high, and vice versa. Sharp price changes reflect high volatility.
     
   • When prices move outside the bands, a continuation of the current trend is implied. That is, in an uptrend, as the price pattern tags and moves through the upper band, strength in the uptrend is manifest.
     
   • Bottoms and tops made outside the bands followed by bottoms and tops within the bands suggest a reversal in the current trend. Psychologically, the “outside top” and “outside bottom” are a “last hurrah,” confirmed by weaker tops & bottoms, implying a change is in the offing.

6. Another “stand-alone” feature of BB’s is called the “Squeeze,” the result when volatility falls to very low levels. The significance of the squeeze is related to how low the volatility is relative to historical levels. The next chart is such an example, where the volatility falls to record low levels. This relates directly to the first BB rule above, suggesting a sharp price change will come out of this squeeze. Point: The squeeze doesn’t tell us whether the price change will be up or down! In the next chart, the resulting change was to the upside.
   
   Fig. 3 A classic example of the Squeezed in action.
   
   Fig. 4 A closer look at the Squeeze in action.

7. The next chart shows a less dramatic squeeze in duration, however the upside possibilities are notable.
   
   Fig. 5 A less dramatic example of the Squeeze in action.

8. There is one important feature of the squeeze that often amazes us. Near the end of the squeeze, as the price is ready to break up or down, it can stage a short fake-out move called the “head-fake,” then abruptly switch direction into the emerging trend. The next price chart is such an example.
   
   Fig. 6 The squeeze, a head-fake, and a breakout

9. Interesting point in the next chart, where the price pattern worked its way up through the moving average, then using that average as support for what follows.
   
   Fig. 7 Price pattern using the MA as support in the uptrend.

10. That is not always the case as shown in the next example. That is, we cannot know for certain the price will not cross below the MA in its uptrend. The best guide in these matters is to look at how the pattern has behaved in the past on this particular stock.
    
    Fig. 8 Price pattern using the MA as support in the uptrend does not always work.

11. The next chart shows another case with the price pattern moving through the MA. However, notice the context here. The chart begins with a downtrend in June & July, with the price using the MA as resistance, until the trend change is resolved to the upside. Thereafter, the price uses the MA as support until it moves into what looks like an oncoming squeeze!
    
    Fig. 9 A reversal in trend with the BB’s providing recognizable patterns.

12. The next price chart shows short-term promise, based on what we’ve learned. Look at a current price chart to see where it went.
    
    Fig. 10 A pullback with the strength of volume as well as price in the near-term.

13. In the next chart we see a clear change in character. The Bollinger Bands help clarify the change, with bands narrowing into October, moving down through the MA, as it tags the bottom band. Check the current price chart to see if the downtrend materializes.
    
    Fig. 11 A change in character.

14. In the next example, we see a pullback to the MA support. Point: Don’t wait for the price to tag the lower band to buy, or the top band to sell.
    
    Fig. 12 Price falling to the MA support.

15. Notice how the bounce is off the lower band on the down-trend, then moves to the upper band on the up-trend.
    
    Fig. 13 Price bouncing off lower band on down-trend, the top band on up-trend.

16. Here is an example where the lower band is the best buy point. We would have difficulty buying at the lower band without a crystal ball, however we could catch much of the move as the price jumped through the MA on its way up.
    
    Fig. 14 Price staging a dramatic change in direction with the Bollinger Band messages.

17. A case showing how high volatility breeds low…
    
    Fig. 15 Cyclical nature of volatility.

18. An example where the price during the recent uptrend has tagged the bottom BB in its rise. That said, is the price at this level a good buy? Check a current chart to see.
    
    Fig. 16 Near-term buy, or hesitation?

19. As we look at chart patterns with aids like BB’s, there is always the dinger that lies in the underbrush. The next chart shows an out-of-character plunge that would have caught us flat-footed. Even a tight stop in place would have still cost us dearly. Look at the news screen below the price chart for news messages. This is the news format on TCNet/TC2000 that appears with each price chart. It is essential to know what the news says about stocks we are thinking about buying. This format makes it a slam-dunk for ease of service.
    
    Fig. 17 Near-term buy, or hesitation?
    
    Fig. 18 News screen for TCNet charts.

20. In the next chart we see a summary of this lesson's discussion. There is a classy example of the squeeze, support and resistance provided by the MA, and an example of the double-bottom (W) pattern near the middle which we will consider in the next lesson. Your task is to look at dozens of charts in Bollinger Band format to reinforce the lessons we have covered. There are others lessons and rules that will increase our success in the use of BB’s, as well as their use with indicators. Much more to come.
    
    Fig. 19 ANDW price chart showing Bollinger Band applications.
    Click here for a new look at PICK PERFORMANCE
    11-14-03 Pick Selection:

    Main Picks:
    AMSC,APCC,AUGT,CAMD,CVNS,GISX,HRLY,IGT,INNO,IRGI
    Breakouts:
    AGU,AH,ANN,ASTT,AVCI,CLF,CLHB,CX,HIFN,IMOS
    QuickPicks:
    AMSC,APCC,AUGT,CAMD,CVNS,GISX,HRLY,IGT,INNO,IRGI

    For detail and followup on Pro-fundity Tradescape,
    find the link on "Advanced Trading Tools" on the home page.

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