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  7. Bollinger Band Width *
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Bollinger Band Width

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Bollinger Bands measure volatility by placing trading bands around a moving average. These bands are charted two standard deviations away from the average, so as the average changes, the value of two standard deviations also changes. This value comprises the Bollinger Band Width, representing the expanding and contracting of the bands based on recent volatility.

Bollinger Band Width plots in a separate pane below the chart, whereas Bollinger Bands plot as an overlay to the chart.

During a period of rising price volatility, the distance between the two bands will widen (BB Width will increase). Conversely, during a period of low market volatility, the distance between the two bands will contract (BB Width will decrease).

There is a tendency for bands to alternate between expansion and contraction. When the bands are unusually far apart, that is often a sign that the current trend may be ending. When the distance between the two bands has narrowed too far, that is often a sign that a market may be about to initiate a new trend.

Parameters:

  • Period (20) - the number of bars, or period, used to calculate the study. John Bollinger, the creator of this study, states that those periods of less than ten days do not seem to work well for Bollinger Bands. He says that the optimal period for most applications is 20 or 21 days.
  • Band Width (2) - The half-width of the band in terms multiples of standard deviation. Typically 2 is used.
Computation
  1. Calculate the moving average. The formula is:|


    • Pn the price you pay for the nth interval
    • n the number of periods you select

  2. Subtract the moving average from each of the individual data points used in the moving average calculation. This gives you a list of deviations from the average. Square each deviation and add them all together. Divide this sum by the number of periods you selected.



  3. Take the square root of d. This gives you the standard deviation.



  4. Compute the bands by using the following formulas:


    • Pn is the price you pay for the nth interval
    • n is the number of periods you select

Interpretation

Traders generally use Bollinger Bands to determine overbought and oversold zones, to confirm divergences between prices and studies, and to project price targets. The wider the bands, the greater the volatility. The narrower the bands, the lesser the volatility.

Some authors recommend using Bollinger Bands in conjunction with another study, such as the RSI. If price touches the upper band and the study does not confirm the upward move (i.e. there is divergence), a sell signal is generated. If the study confirms the upward move, no sell signal is generated, and in fact, a buy signal may be indicated. If price touches the lower band and the study does not confirm the downward move, a buy signal is generated. If the study confirms the downward move, no buy signal is generated, and in fact, a sell signal may be indicated.

Another strategy uses the Bollinger Bands alone. In this approach, a chart top occurring above the upper band followed by a top below the upper band generates a sell signal. Likewise, a chart bottom occurring below the lower band followed by a bottom above the lower band generates a buy signal.

Bollinger Bands also help determine overbought and oversold markets. When prices move closer to the upper band, the market is becoming overbought, and as the prices move closer to the lower band, the market is becoming oversold. The market’s price momentum should also be taken into account. When a market enters an overbought or oversold area, it may become even more so before it reverses. You should always look for evidence of price weakening or strengthening before anticipating a market reversal.

Bollinger Bands can be applied to any type of chart, although this study works best with daily and weekly charts. When applied to a weekly chart, the Bands carry more significance for long-term market changes.


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