From the March 01, 2011 issue of Futures Magazine • Subscribe!

Using the VIX to time markets

Bollinger bands

Bollinger bands were popularized in the 1980s by John Bollinger. They are simply a standard statistical volatility measure applied to the market. Bollinger plotted them as bands placed above and below a moving average of price.

Volatility, in the case of Bollinger bands, is measured by the standard deviation. This measure changes as volatility increases and decreases. Therefore, the bands widen when volatility increases and narrow when volatility decreases. It is this dynamic nature of Bollinger bands that complements the VIX when they are used together.

The reason for this is the trader doesn’t have to be dependent on some arbitrary reading of the VIX alone. By overlaying Bollinger bands on top of price action, you can see the extreme price levels in relation to the Bollinger bands’ upper or lower band (see “S&P turning points”).

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To identify a bottom forming in the S&P 500, you will want to look for times when the VIX’s price action is trading beyond the upper level of the Bollinger bands’ trading channel. This is critical because it shows an extreme level in the price action where a high-probability reversal lies waiting.

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