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28 Part II: : The Basics  Figure 8.8 Variable volatility during a move, (source: "Bulle" in Analyse Technique Dynamique by Philippe Cahen, Paris, France: Economica Books, 1999.)
Chapter 8: Bollinger Band Indicators BandWidth is most useful for identifying The Squeeze, that situation where volatility has fallen to such a low level that its very lowness has become a forecast of increased volatility (Figure 8.4). The simplest approach to this is to note when BandWidth is at a six-month low. This is explored again in Chapter 15. An important use of BandWidth is to mark the beginning of directional trends, either up or down. Many trends are born in trading ranges when the BandWidth is quite narrow. A breakout from the trading range that is accompanied by a sharp expansion in BandWidth is often the mark of the beginning of a sustainable trend (Figure 8.5). Another important use of BandWidth is to mark the end of strong trends, themselves often born in Squeezes. What youll see is that a strong trend will cause a large expansion in volatility that causes the bands to spread dramatically, so much so that the band on the other side of the trend-e.g., the lower band in an uptrend-will head in the direction opposite to the trend. When that band reverses-turns back up in this case-that leg of the move is at an end. This also can be seen and enumerated in BandWidth. The idea is when BandWidth flattens out or turns down enough to reverse the direction of the Bollinger Band on the opposite side of the trend, the trend is at an end (Figure 8.6). Philippe Cahen, a French analyst, has written on the Bollinger Band patterns that are formed by changing BandWidth. Two patterns he refers to are "bubbles" and "parallels" (Figures 8.7 and 8.8). In each case he finds that volatility has a characteristic signature that, when depicted via Bollinger Bands, allows one to identify significant trading opportunities.3 KEY POINTS TO REMEMBER %b depicts where the last price is in relation to the bands. %b is useful in creating trading systems and signals. BandWidth depicts the width of the bands in a relative manner. BandWidth is used to identify The Squeeze. BandWidth is useful for identifying the beginnings and ends of trends.
CHAPTER STATISTICS First, a bit of background: Take a group of people and measure their heights. Now plot the number of people at each height (58", 59", etc.) on a bar chart. The result will be a normal distribution like that shown in Figure 9.1, a bell-shaped curve around the average height. Most of the people will be grouped around the average height forming the top of the bell. As you get away from the average, there will be ever-fewer people. By the time you get to the tall and short extremes, there will be just a few. Conduct the same exercise with stock-price changes and youll find that the tails, the extremes where the short and the tall were, are too thick. There are too many large gains and large losses, more than you would expect, and not enough small changes, less than you would expect. This means that stock prices are not normally
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