Technical Analysis: Bollinger Bands and Williams %R

Every day, thousands of traders under- and overreact to news, which can create incredibly oversold or overbought conditions in a matter of minutes.

However, once that news has been fully baked into a security, it can leave the stock still dangling in severely oversold or overbought territory.  And it’s at that very moment, you want to pounce on the track for potential mean reversion, or a snap back to the average.

Look at Bristol Myers Squibb (BMY).  The other day it gapped down on earnings, leaving it wildly oversold.  But this was a well-known stock, not some garbage that sells off and stays down indefinitely.  It’s not like BMY would ever go out of business.  So, all we had to do was wait for the news to be fully baked in, and jump.

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But how do we know the exact moment to jump?  That's the easy part.

We begin to look at even more indicators that confirm each other, like the Bollinger Bands and Williams %R.

With Bollinger Bands (plotted at standard deviation levels above and below moving averages), stock prices tend to stay within the upper and lower bands.  Bollinger Bands allow users to compare volatility and relative price levels over a period of time, consisting of the simple moving average (SMA) in the middle, an upper band (SMA plus 2 standard deviations), and a lower band (SMA minus 2 standard deviations).

That’s the in-depth explanation.  In short, we’re watching the stock to bounce either off the upper or lower Band before pivoting in the opposite direction.

Of course, we must then confirm our findings, which we can do with Williams %R.  This is the ultimate momentum indicator that signals oversold and overbought conditions. W%R shows an overbought condition with a numerical range read of 0% to 20%. Oversold conditions are measured with a numerical range read of 80% to 100%.

When these two confirm each other, accuracy can run as high as 80%.  Again, let’s look at Bristol Myers Squibb.  Look at what typically happened in recent history when the lower Bollinger Band in January 2017 was challenged. 

At the same time, Williams hit 100, telling us the stock was greatly oversold.  The same thing happened quite a few times over the years.  But it’s far from perfect.  Just look at the mess between August and October 2016.

Still, if you pull up any chart, index or ETF, you’re likely to find the same results at excessive lows and highs marked by Bollinger Bands and Williams.

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