Bollinger Bands
Introduction
Developed by John Bollinger, Bollinger Bands® are volatility bands
placed above and below a moving average. Volatility is based on the standard deviation,
which changes as volatility increases and decreases. The bands
automatically widen when volatility increases and narrow when volatility
decreases. This dynamic nature of Bollinger Bands also means they can
be used on different securities with the standard settings. For signals,
Bollinger Bands can be used to identify M-Tops and W-Bottoms or to
determine the strength of the trend.
Note: Bollinger Bands® is a registered trademark of John Bollinger.
SharpCharts Calculation
* Middle Band = 20-day simple moving average (SMA)
* Upper Band = 20-day SMA + (20-day standard deviation of price x 2)
* Lower Band = 20-day SMA - (20-day standard deviation of price x 2)
Bollinger Bands consist of a middle band with two outer bands. The middle band is a simple moving average
that is usually set at 20 periods. A simple moving average is used
because the standard deviation formula also uses a simple moving
average. The look-back period for the standard deviation is the same as
for the simple moving average. The outer bands are usually set 2
standard deviations above and below the middle band.
Settings can be adjusted to suit the characteristics of particular
securities or trading styles. Bollinger recommends making small
incremental adjustments to the standard deviation multiplier. Changing
the number of periods for the moving average also affects the number of
periods used to calculate the standard deviation. Therefore, only small
adjustments are required for the standard deviation multiplier.
An increase in the moving average period would automatically increase
the number of periods used to calculate the standard deviation and would
also warrant an increase in the standard deviation multiplier.
With a 20-day SMA and 20-day Standard Deviation, the standard deviation
multiplier is set at 2. Bollinger suggests increasing the standard
deviation multiplier to 2.1 for a 50-period SMA and decreasing the
standard deviation multiplier to 1.9 for a 10-period SMA.
Signal: W-Bottoms
W-Bottoms were part of Arthur Merrill's work that identified 16 patterns
with a basic W shape. Bollinger uses these various W patterns with
Bollinger Bands to identify W-Bottoms. A “W-Bottom” forms in a downtrend
and involves two reaction lows. In particular, Bollinger looks for
W-Bottoms where the second low is lower than the first but holds above
the lower band. There are four steps to confirm a W-Bottom with
Bollinger Bands. First, a reaction low forms. This low is usually, but
not always, below the lower band. Second, there is a bounce towards the
middle band. Third, there is a new price low in the security. This low
holds above the lower band. The ability to hold above
the lower band on the test shows less weakness on the last decline.
Fourth, the pattern is confirmed with a strong move off the second low
and a resistance break.
Chart 2 shows Nordstrom (JWN) with a W-Bottom in January-February 2010.
First, the stock formed a reaction low in January (black arrow) and
broke below the lower band. Second, there was a bounce back above the
middle band. Third, the stock moved below its January low and held above
the lower band. Even though the 5-Feb spike low broke the lower band,
Bollinger Bands are calculated using closing prices so signals should
also be based on closing prices. Fourth, the stock surged with expanding
volume in late February and broke above the early February high. Chart 3
shows Sandisk with a smaller W-Bottom in July-August 2009.
Signal: M-Tops
M-Tops were also part of Arthur Merrill's work that identified 16
patterns with a basic M shape. Bollinger uses these various M patterns
with Bollinger Bands to identify M-Tops. According to Bollinger, tops
are usually more complicated and drawn out than bottoms. Double tops,
head-and-shoulders patterns, and diamonds represent evolving tops.
In its most basic form, an M-Top is similar to a double top. However,
the reaction highs are not always equal. The first high can be higher or
lower than the second high. Bollinger suggests looking for signs of
non-confirmation when a security is making new highs. This is basically
the opposite of the W-Bottom. A non-confirmation occurs with three
steps. First, a security creates a reaction high above the upper band.
Second, there is a pullback towards the middle band. Third, prices move
above the prior high but fail to reach the upper band. This is a warning
sign. The inability of the second reaction high to reach the upper band
shows waning momentum, which can foreshadow a trend reversal. Final
confirmation comes with a support break or bearish indicator signal.
Chart 4 shows Exxon Mobil (XOM) with an M-Top in April-May 2008. The
stock moved above the upper band in April. There was a pullback in May
and then another push above 90. Even though the stock moved above the
upper band on an intraday basis, it did not CLOSE above the upper band.
The M-Top was confirmed with a support break two weeks later. Also,
notice that MACD formed a bearish divergence and moved below its signal
line for confirmation.
Chart 5 shows Pulte Homes (PHM) within an uptrend in July-August 2008.
Price exceeded the upper band in early September to affirm the uptrend.
After a pullback below the 20-day SMA (middle Bollinger Band), the stock
moved to a higher high above 17. Despite this new high for the move,
price did not exceed the upper band. This flashed a warning sign. The
stock broke support a week later and MACD moved below its signal line.
Notice that this M-top is more complex because there are lower reaction
highs on either side of the peak (blue arrow). This evolving top formed a
small head-and-shoulders pattern.
Signal: Walking the Bands
Moves above or below the bands are not signals per se. As Bollinger puts
it, moves that touch or exceed the bands are not signals, but rather
“tags”. On the face of it, a move to the upper band shows strength,
while a sharp move to the lower band shows weakness. Momentum
oscillators work much the same way. Overbought is not necessarily
bullish. It takes strength to reach overbought levels and overbought
conditions can extend in a strong uptrend. Similarly, prices can “walk
the band” with numerous touches during a strong uptrend. Think about it
for a moment. The upper band is 2 standard deviations above the
20-period simple moving average. It takes a pretty strong price move to
exceed this upper band. An upper band touch that occurs after a
Bollinger Band confirmed W-Bottom would signal the start of an uptrend.
Just as a strong uptrend produces numerous upper band tags, it is also
common for prices to never reach the lower band during an uptrend. The
20-day SMA sometimes acts as support. In fact, dips below the 20-day SMA
sometimes provide buying opportunities before the next tag of the upper
band.
Chart 6 shows Air Products (APD) with a surge and close above the upper
band in mid-July. First, notice that this is a strong surge that broke
above two resistance levels. A strong upward thrust is a sign of
strength, not weakness. Trading turned flat in August and the 20-day SMA
moved sideways. The Bollinger Bands narrowed, but APD did not close
below the lower band. Prices and the 20-day SMA turned up in September.
Overall, APD closed above the upper band at least five times over a four
month period. The indicator window shows the 10-period Commodity
Channel Index (CCI). Dips below -100 are deemed oversold and moves back
above -100 signal the start of an oversold bounce (green dotted line).
The upper band tag and breakout started the uptrend. CCI then identified
tradable pullbacks with dips below -100. This is an example of
combining Bollinger Bands with a momentum oscillator for trading
signals.
John Bollinger’s 22 Rules For Using Bollinger Bands
Bollinger band is a band plotted two standard deviations far from a easy shifting average, developed by means of well-known technical trader John Bollinger.Bollinger Bands are broadly and efficiently utilized by forex traders international. Probably the most nice joys of getting invented an analytical methodology corresponding to Bollinger Bands is seeing what other folks do with it. Whereas there are various methods to make use of Bollinger Bands within the forex market, following are a number of ideas that function a excellent starting level.
- Bollinger Bands present a relative definition of excessive and low. By means of definition value is excessive on the higher band and low on the decrease band.
- That relative definition can be utilized to match price action and indicator motion to reach at rigorous buy and sell choices.
- Acceptable symptoms can also be derived from momentum, quantity, sentiment, open passion, inter-market information, and so on.
- If multiple indicator is used the indications must now not be right away associated to at least one any other. As an example, a momentum indicator would possibly complement a quantity indicator efficiently, however two momentum symptoms are not higher than one.
- Bollinger Bands can be utilized in sample reputation to outline/make clear pure value patterns similar to “M” tops and “W” bottoms, momentum shifts, and many others. .
- Tags of the bands are simply that, tags no longer signals. A tag of the higher Bollinger Band is NOT in-and-of-itself a sell signal. A tag of the decrease Bollinger Band is NOT in-and-of-itself a buy signal.
- In trending markets value can, and does, stroll up the higher Bollinger Band and down the decrease Bollinger Band.
- Closes outdoor the Bollinger Bands are in the beginning continuation signals, now not reversal signals. (This has been the foundation for a lot of a hit volatility breakout programs.)
- The default parameters of 20 sessions for the transferring average and standard deviation calculations, and two standard deviations for the width of the bands are simply that, defaults. The true parameters wanted for any given market/process is also completely different.
- The average deployed as the center Bollinger Band will have to no longer be one of the best one for crossovers. Somewhat, it must be descriptive of the intermediate-time period trend.
- For constant value containment: If the average is lengthened the selection of standard deviations must be elevated; from 2 at 20 classes, to 2.1 at 50 sessions. Likewise, if the average is shortened the choice of standard deviations will have to be decreased; from 2 at 20 sessions, to 1.9 at 10 classes.
- Conventional Bollinger Bands are based totally upon a easy transferring average. It’s because a easy average is used within the standard deviation calculation and we are looking to be logically constant.
- Exponential Bollinger Bands do away with unexpected adjustments within the width of the bands as a result of huge value adjustments exiting the again of the calculation window. Exponential averages need to be used for BOTH the center band and within the calculation of standard deviation.
- Make no statistical assumptions in line with using the standard deviation calculation within the building of the bands. The distribution of safety costs is non-commonplace and the everyday pattern dimension in most deployments of Bollinger Bands is simply too small for statistical value. (In follow we usually in finding ninety%, now not ninety five%, of the information inside of Bollinger Bands with the default parameters)
- %b tells us the place we’re in terms of the Bollinger Bands. The place throughout the bands is calculated the usage of an adaptation of the method for Stochastics
- %b has many makes use of; among the many extra vital are identification of divergences, sample acceptance and the coding of trading techniques the usage of Bollinger Bands.
- Warning signs will also be normalized with %b, disposing of mounted thresholds within the course of. To try this plot 50-duration or longer Bollinger Bands on a hallmark after which calculate %b of the indicator.
- BandWidth tells us how broad the Bollinger Bands are. The uncooked width is normalized the usage of the center band. The use of the default parameters BandWidth is 4 occasions the coefficient of adaptation.
- BandWidth has many makes use of. Its hottest use is to indentify “The Squeeze”, however can also be helpful in determining trend modifications.
- Bollinger Bands can be utilized on most monetary time sequence, together with equities, indices, overseas exchange, commodities, futures, options and bonds.
- Bollinger Bands can be utilized on bars of any size, 5 minutes, one hour, day-to-day, weekly, and so forth. The secret is that the bars should incorporate sufficient process to present a strong image of the associated fee-formation mechanism at work.
- Bollinger Bands don’t present steady recommendation; slightly they lend a hand indentify setups the place the chances could also be on your favour.
Conclusions
Bollinger Bands reflect direction with the 20-period SMA and volatility
with the upper/lower bands. As such, they can be used to determine if
prices are relatively high or low. According to Bollinger, the bands should contain 88-89% of price action, which makes a move outside the bands significant.
Technically, prices are relatively high when above the upper band and
relatively low when below the lower band. However, relatively high
should not be regarded as bearish or as a sell signal. Likewise,
relatively low should not be considered bullish or as a buy signal.
Prices are high or low for a reason. As with other indicators, Bollinger
Bands are not meant to be used as a stand-alone tool. Chartists should
combine Bollinger Bands with basic trend analysis and other indicators
for confirmation.
