Adjusting Your Shorts

You may be aware that some traders are very keen on Bollinger bands to help with spotting a shorting situation. Certainly you will want to see general weakness in other indicators, but one of the principles frequently observed with Bollinger bands is that when the price rises to the upper band, it will follow this by dropping to the lower band.

You may ask what about a breakout to the upside? The price is at liberty to do this and will on some occasions. The general rule of thumb with the Bollinger bands is that you look for the stock to touch the band if you want a shorting opportunity, but if the price pierces the band, that is a bullish sign.

Some stocks are not so well behaved, however, as you’ll see if you look at this chart of Transocean, Inc.

The standard Bollinger band is most definitely pierced at the beginning of May, and again at the end of the month leading into June, but the next bars were lower, and did not act in a bullish manner. I hope you would not have gone long at these times, however, as you do not have other indications to support a bullish move.

On this particular chart, the RSI is plotted at the top, and reveals the stock to be rather overbought on those occasions. Other indicators may show you the same message.

The fact is that not all stocks act the way we think they should, and a wise trader observes what the market is doing rather than deciding what it should do, then being disappointed when it disobeys him.

Prices seldom go outside the boundaries when you plot Bollinger bands with the standard values. But if you have a volatile stock, they can exceed these standard settings, and you can certainly change the values that you use to better reflect the stocks activity.

While most technical analysis authorities will talk of the 2 standard deviation distance for Bollinger bands, the value is changeable for a reason, and you may want to use a setting such as 3 standard deviations on some stocks. The following chart has 2.5 and 3 standard deviations added.

You can see that 3 standard deviations much more nearly contains the breakouts, and would defuse your alert condition. You should not obsess about finding an optimum settings for the numbers as this will only frustrate you, but you can, I would suggest, fine tune and find better ones in many cases.