Friday, October 29, 2010

Rare BB Setup Led To Extended Rally

Many years ago I ran across a book on technical analysis written by a french analyst that worked for Credit Suisse. In the book he described a setup with the 12 period 2 SD bollinger bands that occured when the bands were flat and tight for 6+ periods. I devised a way to screen for this setup and found that it did in fact lead to powerful moves, but it was also rare, expecially on the weekly charts.

When it occurs on the daily chart of a stock, you can typically expect a move of 12% to 15%. You can just bracket the high and low of the tight range period and go with the breakout long or short. The breakout will be a fakeout about 30% to 40% of the time, but the risk/reward is excellent. Another aspect that occurs frequently with this setup is that after the rally or selloff ends, the stock tends to reverse sharply the other way. It's like all of the explosive force that was pent up has been expended, and there is no energy left to keep the trend going.

The breakout from the flat and tight bands on the weekly chart of the Qs led to an 11% rally from the high of the range, but now we are probably approaching the end of the rally, and the reversal could be dramatic. (Of course, the darn thing could just keep going, too.)

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