FOREX Money Trader
FOREX Money Trader
Our Site is dedicated to providing as much straight forward information
as we possibly can without all the extras hype. Currency knowledge
that's empowering.
MLD
Our Site is dedicated to providing as much straight forward information
as we possibly can without all the extras hype. Currency knowledge
that's empowering.
MLD
| Foreign Currency Exchange Information: Bollinger Bands |
| Bollinger Bands |
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| Copy Right 2008 |
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| "Currency Knowledge That's Empowering" |
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Bollinger Bands are three lines on a price chart, gathered around the price bars. The middle line is a moving
average, and the upper and lower lines are outside most of the values. They are an indication of the expected range
of values of a price. They are concerned with and developed from the price volatility experienced, and thus give a
continually updated logical range that you can follow to see the expected bounces, and identify breakouts. There
are many ways that Bollinger Bands have been used for trading analysis, and we detail the most common here.
First, volatility. This is an indication of the variation between the highs and lows experienced, or can be thought of as
variation from an average price line. How wild are the fluctuations? Statisticians are able to quantify this by the
concept of how much they would expect the price to vary for how much of the time. While other measures are
available for volatility, economists tend to think about the “standard deviation”, which is calculated from the
differences in the actual price from the average price. Stock prices do not exhibit “normal distribution”, so the
standard deviation is not as accurately definable as in classical statistics, but it does still give a measure.
Bollinger Bands, called such because John Bollinger is credited with inventing them in the 1980s, are probably the
most popular measure of volatility used in trading. They provide a calculated range for high and low prices, together
with a moving average centerline, and because they are calculated dynamically they can vary in response to the
market, and show volatility trends. In other words, they provide a constantly moving relative gauge of what is a high
price and what is low.
The fundamental idea is that the bands indicate when prices are high and when prices are low – in this way, it is
similar in concept to drawing support and resistance levels on the price chart, but it eliminates the subjectivity
involved with those, and is self-adapting to changing conditions. The bands are typically drawn with a twenty day
simple moving average in the center, and two standard deviations bandwidth, but these are starting points, and may
be varied with the market to advantage. The theory is that prices will tend to fluctuate between the upper and lower
bands for the majority of the time.
Most charting applications will allow you to draw Bollinger Bands selecting your own parameters, but the default
values are sufficient to explore the concept. There are two basic ways that you can view Bollinger Bands. In one
view, you expect that they provide a constantly adjusting ceiling (if in an uptrend), that the price will follow when
trending. You will note that often the price in an uptrend tends to walk up the upper band, which is part of the
perceived magic of the Bollinger Band. When the price falls away from the band, it indicates that the trend is running
out of steam. In a similar way, when the price is going down it will tend to follow the lower line.
An alternative interpretation has the price trading in the range defined by the upper and lower lines, and you define
your expected return from the range of movement shown. In use, should the price leave the upper band, you may
trade the range between the two lines, and this is effective in giving you a price target for the move. However,
Bollinger himself has said that the price tagging the lines is not a signal, but just a tag. He advocates using
additional indicators to determine whether the stock is overbought and thus likely to stop going up, or oversold and
not going down any more, or whether it is a continuation. Nonetheless, one of the most popular ways to trade with
Bollinger Bands is to work within the confines of the bands, entering a countertrend position at one band and exiting
at the other. You may also find some support or resistance on the middle line, at the moving average.
In fact, Bollinger gives this as a way of checking on the time range used for the moving average. He advises that the
proper average is the one that gives support to the first correction when the price is moving up. If the correction
penetrates the moving average, the period is too short; if the correction does not reach the average, then more
periods are needed in the average. The best average is that showing the intermediate trend. You should note that
the optimum period for the moving average has nothing to do with the best value for crossover trading with the
moving average.
A unique power of the Bollinger Bands is in how they not only track the trend, just as moving averages would, but
how they also constrict and expand as the prices move. This provides additional trading information. If the distance
between the upper and lower bands reduces, constricting the range, it may be an indication that a breakout is
coming. In itself, the constriction is generally not a sufficient indicator for trading, but it can be combined with other
indicators or with candlestick patterns to reinforce the view. Note that the breakout can go in either direction, and
may not be a reversal but a continuation breakout.
Bollinger quantifies numerical indicators from his bands, so that they can be compared to other indicators. %b is a
measure of where the price is relative to the bands, and as such can actually be outside the normal zero to 100
range. If the price is below the lower band, then %b will be a negative number, and if over the upper band, then
greater than 100. He also defines band width as being the width of the bands expressed as a per cent of the moving
average. This again gives a numerical value which can be a trigger for action, for example, when the band width for
the S&P 500 is less than 2% (quantifying the constriction), there is often a breakout move. As I said in the beginning,
Bollinger Bands can be used in many alternative ways, and are worthy of study.
average, and the upper and lower lines are outside most of the values. They are an indication of the expected range
of values of a price. They are concerned with and developed from the price volatility experienced, and thus give a
continually updated logical range that you can follow to see the expected bounces, and identify breakouts. There
are many ways that Bollinger Bands have been used for trading analysis, and we detail the most common here.
First, volatility. This is an indication of the variation between the highs and lows experienced, or can be thought of as
variation from an average price line. How wild are the fluctuations? Statisticians are able to quantify this by the
concept of how much they would expect the price to vary for how much of the time. While other measures are
available for volatility, economists tend to think about the “standard deviation”, which is calculated from the
differences in the actual price from the average price. Stock prices do not exhibit “normal distribution”, so the
standard deviation is not as accurately definable as in classical statistics, but it does still give a measure.
Bollinger Bands, called such because John Bollinger is credited with inventing them in the 1980s, are probably the
most popular measure of volatility used in trading. They provide a calculated range for high and low prices, together
with a moving average centerline, and because they are calculated dynamically they can vary in response to the
market, and show volatility trends. In other words, they provide a constantly moving relative gauge of what is a high
price and what is low.
The fundamental idea is that the bands indicate when prices are high and when prices are low – in this way, it is
similar in concept to drawing support and resistance levels on the price chart, but it eliminates the subjectivity
involved with those, and is self-adapting to changing conditions. The bands are typically drawn with a twenty day
simple moving average in the center, and two standard deviations bandwidth, but these are starting points, and may
be varied with the market to advantage. The theory is that prices will tend to fluctuate between the upper and lower
bands for the majority of the time.
Most charting applications will allow you to draw Bollinger Bands selecting your own parameters, but the default
values are sufficient to explore the concept. There are two basic ways that you can view Bollinger Bands. In one
view, you expect that they provide a constantly adjusting ceiling (if in an uptrend), that the price will follow when
trending. You will note that often the price in an uptrend tends to walk up the upper band, which is part of the
perceived magic of the Bollinger Band. When the price falls away from the band, it indicates that the trend is running
out of steam. In a similar way, when the price is going down it will tend to follow the lower line.
An alternative interpretation has the price trading in the range defined by the upper and lower lines, and you define
your expected return from the range of movement shown. In use, should the price leave the upper band, you may
trade the range between the two lines, and this is effective in giving you a price target for the move. However,
Bollinger himself has said that the price tagging the lines is not a signal, but just a tag. He advocates using
additional indicators to determine whether the stock is overbought and thus likely to stop going up, or oversold and
not going down any more, or whether it is a continuation. Nonetheless, one of the most popular ways to trade with
Bollinger Bands is to work within the confines of the bands, entering a countertrend position at one band and exiting
at the other. You may also find some support or resistance on the middle line, at the moving average.
In fact, Bollinger gives this as a way of checking on the time range used for the moving average. He advises that the
proper average is the one that gives support to the first correction when the price is moving up. If the correction
penetrates the moving average, the period is too short; if the correction does not reach the average, then more
periods are needed in the average. The best average is that showing the intermediate trend. You should note that
the optimum period for the moving average has nothing to do with the best value for crossover trading with the
moving average.
A unique power of the Bollinger Bands is in how they not only track the trend, just as moving averages would, but
how they also constrict and expand as the prices move. This provides additional trading information. If the distance
between the upper and lower bands reduces, constricting the range, it may be an indication that a breakout is
coming. In itself, the constriction is generally not a sufficient indicator for trading, but it can be combined with other
indicators or with candlestick patterns to reinforce the view. Note that the breakout can go in either direction, and
may not be a reversal but a continuation breakout.
Bollinger quantifies numerical indicators from his bands, so that they can be compared to other indicators. %b is a
measure of where the price is relative to the bands, and as such can actually be outside the normal zero to 100
range. If the price is below the lower band, then %b will be a negative number, and if over the upper band, then
greater than 100. He also defines band width as being the width of the bands expressed as a per cent of the moving
average. This again gives a numerical value which can be a trigger for action, for example, when the band width for
the S&P 500 is less than 2% (quantifying the constriction), there is often a breakout move. As I said in the beginning,
Bollinger Bands can be used in many alternative ways, and are worthy of study.