Every serious investor should use this simple tool

A week can be an awfully long time in the markets.

It was only on Monday that I called the FTSE a buy. At the time it was looking cheap.

But by the time my piece aired, the market was already pushing up. On Thursday the FTSE came back into its normal trading range, nudging the 6,800 mark as l expected.

And today, the market is back down again! That’s how fast things move.

If you look at this thinking “how on earth can I keep up?” then you’re in luck – it’s easier than you’d think.

Today I’m going to teach you how to use one of the tools of the trade; something I use myself to keep up with the quick-moving markets and time my entry and exit points.

It’s a free tool, it’s simple to use, and it’s so useful that I don’t think any serious investor should be without it.

So why not get going straight away? Timing is everything – get yours right

I’m talking about Bollinger Bands, something I mentioned last time on The Right Side.

And first things first – they’ve got nothing to do with champagne! They were actually created by a famous technical trader called John Bollinger.

If you know a little about statistics, it may mean something to you when I say that Bollinger Bands plot two standard deviations from the stock’s 20-day moving average.

If you don’t, it’s simpler to say a Bollinger Band measures volatility against the stock’s recent price. In a nutshell, it tries to identify the range in which the stock should trade 95% of the time.

As you can imagine (even if you don’t quite understand the stats!) that’s a seriously handy bit of information to have.

Let’s look at the chart below to illustrate.

Bollinger Bands in action

So here we have the FTSE 100 with its 20,2 Bollinger Band. ‘20,2’ simply means that it’s two standard deviations from the 20-day moving average.

Notice how the bands narrow, and widen – that’s all to do with how volatile the underlying stock is at any given moment.

FTSE 100 chart with Bollinger bands

How do you use this information to time your entries?

Well, for instance, a good time to enter the FTSE was at the beginning of the week when it was touching the lower bound of its range (see the red arrow).

It’s exactly the same if you’re selling, only this time, you want to be hitting the top of the band.

There are two things to bear in mind here: a quick glance at the chart will show that the tool isn’t infallible. The price can hit the lower bound, and then continue falling. But there are more hits than misses. And that stands to reason – I mean, you’re always better off buying cheaply.

And I also want to emphasise the point that these bands don’t tell us anything about the relative merit of a stock, or a market. But if you’ve already made your mind up to invest, then they can certainly help pick an entry point.

So how do you do it yourself?

Four simple steps to charting success

There are all manner of charting packages out there. Most reasonable packages give the option to overlay Bollinger Bands. Some may even allow you to change the number of days in the moving average, or the number of standard deviations.

For today, we’re keeping things simple (and free!), so I’m going to use the package on the MoneyWeek website here.

1. Click the link above, then below the chart that appears, click ‘customise chart’.

2. Type in the ticker of the company, ETF, currency or whatever it is you’re looking to trade. The chart defaults to the FTSE 100 – so if that’s what you want, then just leave it as it is.

3. Choose the period you want to chart – from one day to ten years. I usually start with a six-month chart, then go back for longer periods to get a better idea of what’s going on.

Now comes the key thing – adding Bollinger Bands.

4. To do this, under ‘Overlays’ you simply put a tick in the ‘Bollinger Bands’ box.

Hit ‘draw’ and you’re in business.

Run this chart every day

I can’t begin to tell you how invaluable this tool has been for me over the years – and if I’m preaching to the converted, then I apologise.

Of course, Bollinger Bands aren’t the be-all and end-all. They can give false signals and they tell you absolutely nothing about the fundamentals of the company, or market involved. But there’s no doubt in my mind that they can give you an extra advantage… they can take the emotions out of timing a trade and help you get a great price.

There’s no reason why you shouldn’t be running these sorts of charts every day, and for any investment you’re looking to make.

Have a play around and see if you can find any interesting opportunities.

Whether it’s an individual stock, a fund, or even holiday currency, always remember the trader’s motto: buy low, sell high.

• Bollinger Bands are the registered trademark of John Bollinger. 

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