Bollinger Bands Can Help Take Emotion Out of Investing

Investors who fall prey to their own emotions – and are less than pleased with the resulting investments - can temper gut impulses with an array of technical tools used to assess markets.

A recent survey by MillionaireCorner shows that many affluent investors make financial decisions based solely on emotion. More than 40 percent of both Millionaire and non-Millionaire investors interviewed in May said they have made investment decisions without doing any research or background investigation. The investors were not happy with their results and gave their emotion-based investments a “failing grade,” a score of 44 out of 100.

MillionaireCorner research also reveals that men are much more likely to make impulsive financial decisions. Nearly half the men reported making emotionally based investment decisions, compared to one-third of the women.

Technical analysis aims to take emotion out of investing by applying rules that describe the way investments fluctuate in a free market, explains the Market Technicians Association in a report for individual investors. Technical analysts or “chartists” seek to forecast future prices of investments and markets by analyzing past trading action. According to the association, “Technicians seek to profit by anticipating the mass psychological biases of buyers and sellers in a broad range of markets.”

Technical analysis of securities dates back over 200 years to a time when Japanese nobility traded coupons against future rice harvests, said the association. Changes in rice coupons were charted and eventually used to anticipate price changes. Centuries later the basic tenets of this analysis endure.

“Prices change because of the fear and greed that investors were born with,” said the association, “and by focusing on indicators of this fear or greed a technician can form and actionably plan to invest, whether for the very short term or long term.

Bollinger Bands are a technical trading tool created in the early 1980s by John Bollinger, a chartered financial analyst and a widely recognized leader in the field of technical analysis. His tools have been integrated into most of the analytical software and charting platforms used by investors today.

Bollinger Bands are trading bands that consist of a set of three curves drawn in relation to securities prices, according to the website sponsored by the inventor of the tools. The middle band is typically a simple moving average of prices, while the upper and lower bands provide a measure of volatility and are typically two standard deviations of the moving average. The band parameters can be adjusted to suit different investment objectives.

Trading action “near the edges of the envelope” can indicate whether prices are nearing predictable upper and lower limits, and can help investors decide whether to buy, sell or hold securities. When a price touches one band it tends to reverse and move toward the other side. Prices that breakout of the bands are indicators of market volatility and a signal that the bands will move farther apart. Bands that move closer together signal less volatility.