It’s been an up and down start to 2024 for US stocks thus far (the S&P 500 is flat more than halfway through January), as markets have struggled to maintain last year’s momentum. Mostly positive company results in the early goings of this earnings season have bumped up against overly aggressive expectations for rate cuts, stubborn prices for some goods, and global conflicts.
What are the charts saying? One technical indicator—Bollinger Bands—suggests investors may be feeling uncertain about US stocks over the short term.
How to use Bollinger Bands
Bollinger Bands are a short-term trading tool that can help you decide when to make your move by assessing the relative strength—or momentum—of an investment.
This indicator looks like an envelope that forms an upper and lower band around the price. Between the 2 bands is a moving average, typically a 20-day simple moving average (SMA).1 John Bollinger, who created this indicator, considers the price relatively low (attractive) if it is near the lower band, and relatively high (overvalued) if it's near the upper band.
What the bands say about stocks now
Currently, the S&P 500 is in the middle part of the band, which suggests US stocks are neither overvalued nor undervalued based solely on this indicator (see Bollinger Bands applied to the S&P 500® Index chart below).
When there is neither a buy nor sell signal generated by this indicator, that could suggest employing market-neutral strategies. Of course, the signal could change at any time. Recently, the S&P 500 has trended lower, and a move toward the lower band might generate a buy signal.
Additional signals can be generated for moves outside of the bands. For example, when the stock breaks through the upper band, some traders believe this generates a buy signal (breaking through a resistance level). When it breaks below the lower band, some traders believe this is a sell signal (breaking through a support level). As the chart shows, the S&P 500 is currently still inside of the bands.
It’s worth noting that Bollinger believes a close either above the band or below the band is not necessarily a reversal signal, but rather a continuation pattern.
Volatility and Bollinger Bands
Bollinger Bands can also help assess volatility. Narrowing Bollinger Bands (i.e., when the bands move closer together) could suggest that volatility is decreasing—as investor sentiment potentially becomes more optimistic or complacent. As the chart above shows, the bands have narrowed somewhat of late, suggesting there may be some short-term complacency.
Another pattern of note is a Bollinger Band "squeeze." This occurs when volatility reaches a relative low in the context of recent price action. This squeeze can be followed by a period of increased volatility and may result in a significant move by the stock to the upside or the downside. Bollinger Bands are not currently suggesting a squeeze.
Advanced use of Bollinger Bands
An advanced application of Bollinger Bands involves another indicator: the relative strength index (RSI). Bollinger Bands can be applied around the RSI line to assess additional buy and sell signals.
When RSI is near an extreme high (~100) or low (~0), and is touching either the high part of the upper band or the low part of the lower band, the RSI line could pull back sharply from the band. Bollinger Band analysis holds that a failure of RSI to touch the upper band on a second try generates a sell signal. At extreme lows, a failure of RSI to reach the lower band triggers a buy signal. This is similar to double top and double bottom patterns, respectively, that can occur for the price. Currently, RSI is not near extreme highs or lows.
Using Bollinger Bands
It goes without saying that you shouldn’t make investing decisions based only on the signals given by a single indicator or data point. Bollinger Bands can be used in combination with other research, and you should always consider the risk that the signal does not pan out.
There are reasons to be bullish and bearish right now based on both the charts and the fundamentals of the global economy. If you actively trade, keep an eye on as much information as you can—including what’s happening in the charts.
