Greg Bender of Bloomberg Tradebook recently said to watch out for a spike in mentions of Bollinger Bands in the financial press, and he's a nice guy so let's do our part to prove him right and talk about them.
First, you may ask, what are Bollinger Bands and why do I have to pretend to be an expert on them right now? The concept was created by John Bollinger in the 1980s to help quantify how wild or calm trends in individual securities or the entire market are and to try to identify turning points.
There are three bands. The middle band is a moving average -- usually the average price over the past 20 days. An "upper band" is usually two standard deviations above the moving average, and the "lower band" is two standard deviations below it.
For example, look at the upper and lower bands surrounding the chart of the S&P 500's lowest daily levels over the past two years, and you can see how a breach of the lower band tends to lead to a sharp rebound:
So why is everyone jazzed up about these bands right now? Because of how narrow the distance has become between the upper and lower bands. Add this to the list of ways to quantify how quiet the U.S. stock market has been since late July: The space between the two bands, measured as a percentage of the 20-day moving average, shrunk this month to the smallest since August 1995 and is now 1.129 percent.
The thinking goes that at times like this, the market has become like a spring that's compressed tightly and prone to making a big move. The question is which direction.
After the bands became even narrower in August 1995, the S&P 500 surged about 11 percent by the end of the year and was 21 percent higher by May 1996. After another unusually tight range in early August of 1993, the index surged 3.4 percent by Sept. 1 and was almost 8 percent higher by February.
But a narrow 1.29 percent width resolved itself in the opposite direction just two years ago: the S&P 500 dropped almost 7 percent between the middle of September and the middle of October in 2014.
So, bottom line, don't be too surprised if this exceptionally quiet market is a prelude to a big move, even if the Bollinger Bands can't necessarily predict which direction it will be. But what fun would that be anyway?
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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