Bollinger Bands

Type

Self –adjusting Volatility Envelope

History

John Bollinger invented Bollinger Bands.

How does it work?

Bollinger Bands are an indicator that allows users to compare volatility and relative price levels over a period time. The indicator consists of three bands designed to encompass the majority of a security's price action.

Bollinger Bands are plotted at standard deviation levels above and below a moving average. A distinct characteristic of Bollinger Bands is how the spacing between bands varies based on the volatility of prices.

Trading Signals

Since the standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods.

Bollinger bands can help generate buy and sell signals, but they do not determine the future direction of a security. By themselves Bollinger bands serve two primary functions: 

Mr. Bollinger notes the following characteristics of Bollinger Bands:

Settings

Short term: 10 day Simple Moving Average, with bands at 1.5 standard deviations

Medium term: 20 day Simple Moving Average, with bands at 2 standard deviations

Long term: 50 day Simple Moving Average, with bands at 2.5 standard deviations

Sharechart Default:  20 day Simple Moving Average, with bands at 2 standard deviations

Note: Mr. Bollinger recommends using "20" for the number of periods in the moving average. He has also found that moving averages of less then 10 periods do not work very well.

Example

Axa Asia Pacific Holdings Limited is used as an example below:

1.      Band tightens as share price remains in narrow range

2.      Price breaks through narrow range, with bands expanding – note that the share price stays close to the upper band as it rises3.      Price share channels sideways with band narrowing – note that the share price ran down to touch bottom band where it found support

4.      Price breaks up with the expansion of the band – note once again the share price hugs the upper band on the way up

5.      Band narrows as price runs down to touch bottom band

Band begins to expands, this time price moves down – note price is hugging lower band on the way down