Are the Bollinger Bands Foreshadowing a Big Move?

It’s fascinating how fast people’s sentiment has been changing, in both directions, over the last few months. Yesterday we had a down day with small caps ($IWM) and Transports ($IYT) showing noticeable weakness. Taking a look at my twitter stream you would have thought the world exploded. I saw numerous tweets of people calling to batten down the hatches, many of which had been bullish just the day before. Can a single day’s price action have this much affect? Or are traders THAT nervous about a correction that just a 1% move makes them change their underpants?

So where do I stand? I still reference the charts that could end the rally and that the equity market is playing a game of Jenga, but it takes more than a one day drop to make me put on a helmet. It would be weird if we didn’t touch the 1576 high in the S&P, but price leads and if it’s helmet time then it’s helmet time, who am I to fight Mr. Market?

The chart I want to share today is the Bollinger Bands around the S&P 500 ($SPX). With the lack of volatility (standard deviation not the $VIX) the bands have tightened. Take a step back we can see that the Bollinger Bands have only been this tight six previous instances on a daily chart since 2006. The most recent time being late-August of last year before the S&P shot higher by about 70 points over seven trading days.

When Bollinger Bands tighten like this it typically precedes a large move in either direction. By just using the bands we can’t forecast the direction of the move, we can just know that a large move is likely. As I said earlier, I would be surprised if we didn’t at least kiss the 2007 intraday high, but the weakening internals may just be strong enough to pull the rug from underneath the bulls before they get the chance.

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