What is the Bollinger Bands Technique?

This indicator was developed by John Bollinger and is explained in detail in his opus called Bollinger on Bollinger Bands. The technique involves overlaying three bands (lines) on top of an OHLC bar chart (or a candlestick chart) of the underlying security.

The central band is a simple arithmetic moving average of the daily closes using a trader-selected moving average index. The upper and lower bands are the running standard deviation above and below the central moving average. Since the standard deviation is a measure of volatility, the bands are self-adjusting, widening during volatile markets and contracting during calmer periods.

Bollinger recommends 10 days for short-term trading, 20 days for intermediate-term trading, and 50 days for long-term trading. These values typically apply to stocks and bonds, thus shorter times will be preferred by commodity traders. See Figure below.

[caption id="attachment_13116" align="aligncenter" width="550"]Bollinger Bands Bollinger Bands[/caption]

Bollinger bands require two trader-selected input variables: the number of days in the moving average index and the number of standard deviations to plot above and below the moving average. More than 95 percent of all daily closes fall within three standard deviations from the mean of the time series. Typical values for the second parameter range from 1.5 to 2.5 standard deviations.

As with moving average envelopes, the basic interpretation of Bollinger bands is that prices tend to stay within the upper and lower bands. The distinctive characteristic of Bollinger bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (that is, high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (that is, low volatility), the bands narrow to contain prices.

Bollinger notes the following characteristics of Bollinger bands:

Bollinger bands do not generate buy and sell signals alone. They should be used with another indicator, usually the relative strength indicator. This is because when price touches one of the bands, it could indicate one of two things: a continuation of the trend or a reaction the other way. So Bollinger bands used by themselves do not provide all of what technicians need to know, which is when to buy and sell. MACD can be used in conjunction with Bollinger bands and RSI.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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