Bollinger Bands as dynamic support and resistance

I use Bollinger Bands, in part, because they provide dynamic support and resistance. This concept is explained in great detail in Philippe Cahen's book, Analyse Technique et Volatilite (still published only in French). I have noticed that this is particularly true in a consolidation period following a sustained price movement, as shown in the above chart example of this tick chart. (The strong price movement was depicted at the bottom of my last post. The chart above shows only the consolidation phase.) Note how well the Bollinger Bands, shown in purple, provide dynamic (vs. static with many other forms, like Fibonacci numbers) support and resistance. Prices have a tendency to reverse at prices very close to these Bollinger Bands. Since Bollinger Bands are based upon the science of statistical analysis, this holds true for most liquid financial instruments. When prices close outside the Bollinger Bands, this is indicative of rising volatility, and thus, increased momentum in the direction of the prices. Following a consolidation, this is a signal to take a trade in the direction of that Bollinger Band break-out.

When prices (move and) close too far outside the Bollinger Bands, they have a tendency to snap back inside those bands, at least temporarily. In a strong move like what we are seeing in todays grains, prices will show a pattern like the one above (first chart at the top of this posting) on shorter time frames, while they will appear to move back inside the Bollinger Bands for a period, as shown on the second chart depicted here of the 3-minute chart. The consolidation in the chart at the top of this post is also depicted in the section where I have placed the red arrow in the second chart (above right).

Prices and the Exponential Moving Average
Interestingly, as prices approach the Exponential Moving Average in this second chart (shown as a blue line), they are more likely to surge to even higher highs, as we can also see has occurred in this second chart. If prices close below the EMA instead of moving higher, then prices are more likely to consolidate (greatest probability) or even reverse. A reversal is more likely following a consolidation rather than a sudden reversal in an uptrend. In the example shown (above right with red arrow), after prices closed below the EMA (when the blue line changed to red at the second-to-last completed candle, which was red), a consolidation emerged immediately after the screen capture of this chart was made. Another clue of quickly-falling volatility and and end to the price movement is manifested also by the new high price (third from last completed candle -- a slightly imperfect gravestone doji for those trained in Japanese candlesticks) that closes within the Bollinger Bands. This phenomena withe the EMA is also proliferated into the 15-minute chart, as prices later moved upwards again as the EMA in the 15-minute chart provided additional support (not shown, as it occured after these screen captures were made).

Bollinger Bands and the Triptych

This is one reason why I keep multiple time frames on my charts at all times (as shown in the third chart in this post just above this paragraph), because I want to have the perspective of what the Bollinger Bands are doing on higher time frames as well. Cahen calls this a triptych in his book, a perfectly appropriate term. This proliferation of patterns from one time frame to the next occurs with a high degree of reliability on all time frames. Note that the period shown in the first chart above as a consolidation, is also depicted in this second chart as a period of flat trading, following a strong movement outside the purple Bollinger Bands, which resumes once prices approach the Exponential Moving Average. When prices move so rapidly so fast, and thus move farther outside the Bollinger Bands than is statistically reliable, a period of resting prices (consolidation) is needed before prices can resume their upward path. Cahen also explains this concept in considerable detail in his book. I think of it as being somewhat like a rubber band. The more tension that is created on a rubber band, the more likely it is to snap back with some force.

Since Bollinger Bands are based upon statistical analysis, anyone who has been trained in statistics and an understanding of standard deviations from a mean can understand how this force influences prices in the financial markets. Bollinger Bands are based upon standard deviations from a mean, and thus, they can help us to read and understand the financial markets.

Higher Prices and Inflation Ahead?!
This surge in prices is suggestive of continued bullish price strength in the longer-term charts for the grains. We should see still higher prices (new all-time highs in soybeans) very soon. The all-time high price in a front-month contract in soybeans is still $12.90. This price may provide some resistance, but I expect it to be eliminated soon, probably within the next few trading days.

If, in Fed Chairman Bernanke's speech today, he attempts to minimize the inflationary influence of high commodity prices, and/or he signals the markets that lower interest rates and looser monetary policy lie ahead into the foreseeable future, this price surge to higher highs will probably occur sooner rather than later. $12.90 soybean prices may very soon be a very distant memory in the past, despite dissipating momentum and selling volumes on the daily chart (see my previous post earlier today)! This could cause buyers to step into the market once again to force the Klinger volume indicator to begin moving upward again and resume the uptrend in soybeans and other commodity prices.

Can you spell inflation? I knew you could!