Do financial markets adapt to widespread use of an indicator, such as Bollinger Bands, thereby extinguishing its informativeness? In the August 2014 version of their paper entitled “Popularity versus Profitability: Evidence from Bollinger Bands”, Jiali Fang, Ben Jacobsen and Yafeng Qin investigate the effectiveness of Bollinger Bands as a stock market trading signal before and after its introduction in 1983. They focus on bands defined by 20 trading days of prices to create the middle band and two standard deviations of these prices to form upper and lower bands. They consider two trading strategies based on Bollinger Bands:
- Basic volatility breakout, which generates buy (sell) signals when price closes outside the upper (lower) band.
- Squeeze refinement of volatility breakout, which generates buy (sell) signals when band width drops to a six-month minimum and price closes outside the upper (lower) band.
They assess the popularity (and presumed level of use) of Bollinger Bands over time based on a search of articles from U.S. media in the Factiva database. They evaluate the predictive power of Bollinger Bands across their full sample sample and three subsamples: before 1983, 1983 through 2001, and after 2001. Using daily levels of 14 major international stock market indexes (both the Dow Jones Industrial Average and the S&P 500 Index for the U.S.) from initial availabilities (ranging from 1885 to 1971) through March 2014, they find that: Keep Reading