Table 15-1.

(Upper BB -

Part III: Bollinger Bands on Their Own BandWidth Formula lower BB)/middle BB

historically low levels, The Squeeze is on. An indicator called BandWidth (see Table 15.1) was created in order to measure The Squeeze.1 BandWidth depicts volatility as a function of the average (Figure 15.1). As such it is comparable from security to security, across time, and across markets. As we have seen earlier, volatility is highly variable over time. It is precisely this variability that is the key to The Squeeze.

The Squeeze has several definitions. The simplest one-one that will do admirably for our purposes-is that a Squeeze is triggered when BandWidth drops to its lowest level in six months.2

For some years there has been an academic theory in circulation that suggests that while price is neither cyclical nor fore-castable, volatility is both. (You might want to reread Chapter 9,

3/00 4/00 5/00 8/00 7/00 6/00 9/00 10/00 11/00 12/00 1/01 2/01

Figure 15.1 Bollinger Bands and BandWidth, IBM, 250 days. Band-Width falls from over 40 percent to less than 10 percent in 20 days.

Chapter 15: The Squeeze

"Statistics," now.) The bit about volatility is right on, though price does exhibit elements of cyclicity and forecastability.

For example, in the U.S. stock market there are strong seasonal trends. Both an annual and a four-year pattern are quite clear and can be used to great advantage. Indeed, the four-year cycle can be used to explain much of the variability in the annual cycle. From quite a different vantage point, John Ehlers has shown that commodity prices contain useful cyclical information in the short term.

So, while the part of the proposition that suggests price is neither cyclical nor forecastable seems overstated, there is substantial evidence that volatility both exhibits cycles and is forecastable that confirms the second half of the theory. For example, examine Figure 15.2, which shows Treasury bond futures and their BandWidth. It demonstrates clearly a 19-day volatility cycle, a cycle that often marks important junctures. It also demonstrates quite clearly the most important aspect of this theory of volatility, that low volatility begets high volatility, and high volatility begets low. If it is a quiet day, expect a storm. If it is a stormy day, expect quiet.

Time and again, we see The Squeeze in action. A consolidation begins. The resulting trading range narrows dramatically. The average flattens and now tracks right down the center of the data structure. The Bollinger Bands begin to tighten around the price structure (Figure 15.3). The stage is set. Now we turn to our indicators. Is volume picking up on up days? Is Accumulation Distribution turning up? Does the range narrow on down days? What is the relationship of the open to the close? Each piece of evidence helps forecast the direction of the resolution. Watch carefully for news, as news is often the catalyst.

Traders beware! There is a trick to The Squeeze, an odd turning of the wheel that you need to be aware of, the head fake (Figure 15.4). Often as the end of a Squeeze nears, price will stage a short fake-out move, and then abruptly turn and surge in the direction of the emerging trend. The head fake was first noted in the S&P 500 Index futures many years ago, and numerous examples have been seen since.

To deal with the head fake, you can wait for the move to develop sufficiently so that there is little question about the nature of the emerging trend. Or if you want to trade The Squeeze right

Figure 15.3 The Squeeze and a breakout, PPL, 150 days. Low volatility begets high volatility.