%b Reaches Extreme Low Level

Posted by barkand on August 5, 2011 under Bollinger bands, Volatility | Be the First to Comment

The US stock market, and alot of markets, got whacked once again yesterday. The market is down more than 10% now just in the last two weeks and nearly half of the loss occurred yesterday. Because of it, %b fell to minus .27. It is only the 11th time since 1990 there has been a reading below minus .25.

So, first, what is %b?

%b is a derivative of Bollinger bands. It tells us where prices are relative to the lower and upper Bollinger bands. The lower band is set to a value of 0 and the upper band has a value of 1. The 20-day moving average is equal to 0.5. When we have a number of minus .27, or plus .27, it means the price has moved 27% beyond two standard deviations of the recent price range. Something which rarely happens. Interestingly, it never happened even once during the 2008-2009 financial meltown.

But now that it has happened, we are interested to predict what will happen next. We searched back to 1990, more than 20 years of data, and found ten other times when %b went lower than -.25. The accompanying table and chart illustrate what we can expect over the next two months (or 40 trading days).

In only one case did the market continue lower. Two other times, the market was basically flat. And in 7 out of 10 times, the market was notably higher with two month returns ranging from 4.4% to 19.4%.

Likewise, if we look only at the next day’s results we see two losers, two roughly flat days, and six gains of 0.5% or more.

So history is pointing us in the direction of a bounce from here, but it is not a slam dunk. You might notice that the worst results came from the most recent time %b fell below -.25 and the best results occurred 20 years ago.