While going through charts last night, I came across Sony
Corp. (SNE), and it reminded me of a recent conversation about the usage of
Bollinger Bands for trend following. I'd like to share with you my methods for using Bollinger bands. I will keep it simple and point
out a few ideas for trade management. Construct your own rules based on your own preferences and risk tolerance.
No indicator is perfect, including
Bollinger Bands; therefore, I like to use Fib numbers, oscillators, patterns, etc. for
a helping hand. Other than a few trendlines, I have deleted all other indicators/notations for the sake of clarity. We are dealing with the
B. Bands here, nothing else.
I typically leave the Bollinger Bands at the standard
2 standard deviations and 20 SMA. When a stock or other instrument is banging
on both sides frequently, while trending, I adjust to make for more useful
signals. With SNE, I left it at the standard 2 and 20. In consolidations,
you will find that the price often moves up and down, tagging both bands, thus
giving range traders signals. That is a lesson for another day and likely from
another author, as I don't range trade.
Let's take a look at the chart:
You can see on the chart that during the last half of
2009 SNE was basically going sideways. It did have a slight upward drift to it
which might have suggested to the trader that a breakout might occur to the
upside at some point. The signal we are looking for is a tag and
preferably a close on or above the top band (for a long position). From July
through December there were a few of these tags that could have been traded and
would have likely resulted in a loss as the price was not following through.
This is where patience and/or other tools come into play.
On January 4 we had the 'Real McCoy'. There was a tag
of the upper band and a strong close on the day. This was our buy signal. We could
either enter at the close or wait a day or two depending on the trader's preference. Often when we close outside the band, the price will come back
inside briefly. This is not a very fast moving stock so this would have been a
reasonable choice. As history tells us, that would have been a fine choice. I
often enter half my position on the day of the signal and then the other half
on a bit of weakness or on confirmation (taking out the high of the signal
day). A close below the 20 Day MA in the few days following the signal would
have negated the signal and called for a sell signal or a non-entry.
Whatever
entry method, certainly by January 8 we are in a full position long. There are
two things we are looking for now. The first is a place to start scaling
out and the second is a place to fully exit. In this case, because it’s not a
stock that I’m wildly bullish about, I would have started looking to scale out.
There were several days of the stock running outside the upper band. This is to
be expected; we were correct! But this means that upside volatility is getting
very high and high volatility begets low volatility. I would now look to cut
the position in half. I like to wait for a daily close back inside the bands to
either get out of half on the close or place a stop just below the previous
low.
Now that we have taken half off the table, we can be
somewhat flexible with the other half. Depending on how strong the stock is
there are two choices of signals I use. The first is for very strong stocks and
that is a close below the 20 Day MA. The second is a tag of the lower band. For
SNE, I would have used the lower band. This can keep you in a trade longer
which hopefully means more profit. We can expect some consolidation after this
burst upward and hopefully get to stay in the trade and hopefully get a chance
to double back up again on another buy signal. On March 3 we were rewarded with
another buy signal so we repeat the process and scale out of the newly acquired
second half according to the same rules as the first half. On April 7 there is
a tag of the lower band and the trade is now exited entirely.
All in all, this
trade would have worked out pretty well. We would have taken about a 10%+
profit on the first half sold, a minimum of around 3% on the second half
purchased and sold in March depending on trading style, and on the original
half 20%+.
"Those who do not read newspapers are uninformed.
Those who do read newspapers are misinformed."
Mark Twain
"Government is the only institution that can take a valuable commodity
like paper, and make it worthless by applying ink." -Ludwig Von Mises
