Bollinger bands are a technical analysis tool that was invented by trader John Bollinger in the 1980s. A Bollinger band consists of upper, middle and lower bands that are plotted two standard deviations away from the moving average of the stock price. These bands are a good indicator of whether a stock price will move higher or lower. When a stock moves closer to the upper band, this suggests that it could break out of its current range and move higher. Likewise, if the stock moves to the lower band, then this is an indicator that the price could fall. The space between the bands is also a good measure of volatility. The bands widen during periods of volatility and contract when it falls. Bollinger bands can also be used as an indicator of how over-bought or over-sold a market is and this information can predict a quick reversal of trend in a stock price.
The price-to-earnings ratio of a stock measures the price paid for the share divided by the annual income the firm earns for each share in the company. For example, if a stock is trading at £10 and earnings per share during the last 12 months were £1.25, then the price-to-earnings ratio is eight times. It is a financial ratio that is widely used by the markets as a way to value a stock. If a stock has a high price-to-earnings ratio then you pay more for each unit of net income. Likewise, if the ratio is low, then you pay less. Usually, a high ratio suggests that investors expect future earnings per share to increase. This ratio can be used to measure how expensive a stock is relative to the rest of the market – a low ratio is often the sign of a cheaper stock. This ratio is most useful when you compare companies within the same sector to the market as a whole. For example, you would not learn much from comparing the consumer durable sector with the technology sector.
The main criticism of the price-to-earnings ratio is that earnings figures can be easily manipulated. Since earnings depend on accounting measures, you must make sure that companies you compare have calculated their earnings in the same way.