When calculating BB Width, the first step is to subtract the value of the lower band from the value of the upper band. This shows the absolute difference. This difference is then divided by the middle band, which normalizes the value. BB Width is simply a graphical representation of the volatility being measured by Bollinger Band overlay. The lower BB Width goes, the lower the volatility and the higher the BB Width goes, the higher the volatility. Not exactly an earth-shattering concept, but it can useful at certain times - such as now.
As I showed in my previous post, the Dow Jones Precious Metals Index, which represents large cap miners, recently broke up and out of a consolidation pattern and is now back-testing its old line of resistance. Gold, shown above, has an almost identical chart (RSI, MACD, consolidation, etc) except for the fact that it is still coiling and has not broken out in either direction (yet). Starting in July 2013, it has made a series of higher lows and lower highs all the while trading in an ever-tightening band between $1,290 and $1,310.
That narrowing trading band is highlighted by the upper and lower Bollinger Bands getting closer and closer together. The decrease in volatility is probably easier to see when looking at the BB Width indicator (bottom panel). After peaking around 35 in July 2013, it has dropped to the current reading of 6.4, the natural level of support for the past five years (horizontal green line).
Let's now take everything the charts are telling us and see what predictions we can make:
- Price has made a series of higher lows since bottoming over 12 months ago.
- Price has made a series of lower highs during the same period.
- The trading range has been narrowing to a very tight band around $1,300/oz.
- MACD and RSI have been in a strong uptrend for over a year even though the gold price has moved sideways. This indicates significant underlying strength.
- The Bollinger Bands are the narrowest they've been in the last five years and BB Width has worked its way into a corner.
- The Dow Jones Precious Metals Index (DJGSP), displaying virtually the same price and indicator patterns, had a bullish breakout two months ago.
Taking all of this evidence into account, I will make the following educated predictions:
- We are going to see a bullish breakout in gold (MACD, RSI, and DJGSP confirmation)
- And it's going to happen very soon and it's going to be very powerful (extreme BB readings)