The potential for big SPX upside has lessened, per this technical analysis tool
Bollinger Bands is a popular technical analysis tool, which is made up of a moving average with upper and lower bands that are usually set two standard deviations away. This tool is generally used to identify overbought or oversold conditions — often buying when the price touches the lower band, and selling when it reaches the upper band.
The S&P 500 Index (SPX) last week closed above its top band. This makes now a good time to examine how the benchmark normally performs after closing outside of its bands.
Closes Outside of Bollinger Bands
Let’s break down SPX returns after closes above the top and below the bottom bands. Before we get into that, though, the table below shows typical returns for the SPX over various time frames, from one week to six months. This table will serve as a benchmark for the returns.
The next table summarizes SPX returns after closes above its top Bollinger Band. For the signal to be generated, it had to be the first close above the band in the past month. Below that are index returns after closes below the bottom Bollinger Band.
Looking at average returns, the Bollinger Bands appear to be decent overbought or oversold indicator. The average returns mostly underperform the benchmark returns after closing above the top band, and outperform the benchmark returns after closes below the bottom band.
Focusing on one-month returns, the SPX averaged just a 0.22% return after closing above the top band, and a 1.02% return after closes below the bottom band, compared to the benchmark average return of 0.59%. Whether the SPX closes above the top band or below the bottom band, there is no real impact to the percentage of positive returns.
The main reason for the underperformance has been the lack of upside after closes above the top band. The average one-month return when considering only the positive returns was 2.36%, which is significantly below the benchmark average positive return of 3.29%.
Another way to think of this is that the positive returns are returning almost 30% less than typical positive returns. After closing below the bottom band, the average positive return for the SPX over the next month was 3.93%, which is almost 20% higher than the typical positive return.
Based on the data since 2000, Bollinger Bands have been a good overbought/oversold indicator. With the recent close above the top band for the SPX, the odds of a pullback don’t seem to increase much, if at all. However, the potential for big upside has been lessened.