Part III: Bollinger Bands on Their Own

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Figure 12.7 w bottom, neither low breaks the bands, The Limited, 100 days. a w completely inside the bands.

pattern forming on the daily chart, look for small-scale patterns on the hourly charts confirming the turns in the larger pattern developing on the daily charts.

Okay, so now you have found a W that fits the rules and that you are comfortable with-what do you do? Buy strength. Wait for a rally day with greater than average range and greater than average volume and buy (Figure 12.8). This day confirms your diagnosis of the formation and sets the stage for the rally.

Your stop should go beneath the most recent low-the right side of the W-and should be incremented upward as soon as is reasonable. Either you may use an approach similar to the Welles Wilders Parabolic System that increments the stop each day, or you may increment by eye, setting the stop a bit beneath the lowest point of the most recent consolidation or pullback.

The room which you give prices to fluctuate by setting your stops will greatly impact your performance. Stops that are set too tight will result in too many broken trades, while stops that are too loose will allow too great a portion of your profits to be retraced.

Chapter 12: W-Type Bottoms

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Figure 12.8 W bottom, buy the expansion day, Chevron, 150 days. A surge in volume plus a large positive daily range after a W is a buy signal.

The best advice is to start with relatively wide stops and tighten them slowly until the risk-reward trade-offs suit your style.

In categorizing lows we find that the formations often have similar fundamental and psychological factors. In this we are reminded of our goal and indeed the purpose of technical analysis: to identify junctures in the market where the odds favor the assumption of a position. In order for this to be true, we must be able to believe in the patterns we are seeing, and in order to believe, we must understand the factors that lead to the formation. Technical analysis is not a stand-alone science; rather it is a depiction of the actions of investors driven by fundamental and psychological facts-or more properly, driven by anticipation of the facts.

The argot of technical analysis is rife with terms that describe various setups, some sharply, some vaguely, and some incompre-hensively. It is only to the extent that such terms successfully model underlying realities that they are useful. For example, a W bottom with a lower right-hand side often becomes an inverted

head-and-shoulders pattern (see Figure 12.9) when a final retest of support occurs after the uptrend has been born-a W8 becomes a W14 or W16 after another two more price swings. Simply put, the nascent uptrend is met with skepticism and profit taking, creating a decline that forms the right shoulder. However, head-and-shoulders formations fit more properly in the domain of top formations, which is what we cover next.

KEY POINTS TO REMEMBER

W bottoms and their variations are the most common.

Spike bottoms do happen, but they are rare.

Ws may be transitions to bases rather than reversals.

Bollinger Bands can help clarify Ws.

Buy strength after the completion of a W.

Set a trailing stop to control risk.

Potential W bottoms are listed each trading day on www.BollingeronBollingerBands.com.