By ChartNexus

After digesting how the Bollinger Band is used to generate high probability buy signals, it is time to reveal how such sell signals are triggered. A bearish signal is triggered when a Bollinger breakout occurs as both bands suddenly diverge with the price hugging the lower band. This is illustrated in Figure 1 where Wilmar International had a Bollinger Squeeze formed in April 2012 with the subsequent bearish breakout at the start of May 2012.

Figure 1: Bollinger Squeeze and subsequent bearish breakout

We can further enhance the Bollinger breakout that comes after the Bollinger Squeeze with another indicator, thereby increasing the probability of making a trade in the right direction of the breakout. One popular indicator that can be used together with the Bollinger Squeeze is the Relative Strength Index (RSI) which was developed by J. Welles Wilder. The RSI is a powerful indicator used to measure the velocity of the price movements and the values are calculated based on the number of days that the price closes up and the number of days that the price closes down over a certain period of time.

In this article, the time period used is 14 days, which is originally proposed by Wilder. Figure 2 shows the chart of STX OSV Holdings using the RSI indicator in conjunction with the Bollinger Band. An analysis of the RSI indicator shows that the RSI was well supported during the Bollinger Squeeze and was trending upwards as the price approached the Bollinger breakout. This signifies that the price action remained firm throughout the Bollinger Squeeze and it grew in strength as the breakout came beckoning.

This article has highlighted the importance of understanding the volatility of the stock market in order to make profitable trades. A powerful indicator such as the Bollinger Band is widely used to identify buy and sell signals based on two applications. The first involves using the bands as support and resistance with the second involving a search for a Bollinger Squeeze followed by a Bollinger breakout. Combining the Bollinger Band with the RSI indicator further increases the probability of the signal being a valid one.

ChartNexus is a regional company providing FREE charting software for the investment community. The company also organises investment seminars and training programmes on a regular basis, promoting the use of technical analysis. For more information, please visit www.chartnexus.com or email sgevents@chartnexus.com.