Bollinger Bands
Bollinger Bands Technical Indicator (BB) is similar to Envelopes.
The only
difference is that the bands of Envelopes are plotted a fixed distance (%)
away from the moving average, while the Bollinger Bands are plotted a
certain number of standard deviations away from it. Standard deviation is a
measure of volatility, therefore Bollinger Bands adjust themselves to the
market conditions. When the markets become more volatile, the bands widen
and they contract during less volatile periods.
Bollinger Bands are usually plotted on the price chart, but they can be also
added to the indicator chart (Custom Indicators). Just like in case of the Envelopes, the interpretation of the Bollinger Bands is based on the fact that
the prices tend to remain in between the top and the bottom line of the bands.
A distinctive feature of the Bollinger Band indicator is its variable width due to
the volatility of prices. In periods of considerable price changes (i.e. of high
volatility) the bands widen leaving a lot of room to the prices to move in.
During standstill periods, or the periods of low volatility the band contracts
keeping the prices within their limits.
The following traits are particular to the Bollinger Band:
- abrupt changes in prices tend to happen after the band has contracted
due to decrease of volatility.
- if prices break through the upper band, a continuation of the current
trend is to be expected.
- if the pikes and hollows outside the band are followed by pikes and
hollows inside the band, a reverse of trend may occur.
- the price movement that has started from one of the band’s lines
usually reaches the opposite one. The last observation is useful for
forecasting price guideposts.
CalculationBollinger bands are formed by three lines. The middle line (ML) is a usual
Moving Average.
ML = SUM [CLOSE, N]/N
The top line, TL, is the same as the middle line a certain number of standard
deviations (D) higher than the ML.
TL = ML + (D*StdDev)
The bottom line (BL) is the middle line shifted down by the same number of
standard deviations.
BL = ML — (D*StdDev)
Where:
N — is the number of periods used in calculation;
SMA — Simple Moving Average;
StdDev — means Standard Deviation.
StdDev = SQRT(SUM[(CLOSE — SMA(CLOSE, N))^2, N]/N)
It is recommended to use 20-period Simple Moving Average
as the middle
line, and plot top and bottom lines two standard deviations away from it.
Besides, moving averages of less than 10 periods are of little effect.