Bollinger Bands are upper and lower “envelope” lines plotted at standard deviation levels above and below a moving average. They predict the trading range of the red line.
Since standard deviation is a measure of volatility, the bands are self-adjusting, widening during volatile markets and contracting during calmer periods.
Interpreting Bollinger Bands
Bollinger purple upper and cyan lower bands provide a trading range for the red line price. The spacing between the bands is based on the volatility of the prices.
- During periods of extreme price changes (high volatility), the bands widen to envelope strong price moves.
- During the periods of stagnant pricing (low volatility), the bands narrow.
The creator, John Bollinger, notes:
- Sharp price changes often occur after the bands tighten, as volatility lessens.
- When prices move outside the bands, a continuation of the current trend is implied.
- Bottoms and tops made outside the bands followed by bottoms and tops in the red price line made inside the bands call for reversals in the trend
- A move that originates at one band tends to go all the way to the other band. this observation is HOHseful when projecting price targets.
Bollinger Bands have two adjustable parameters, P (period of the Exponential Moving Average) and D (the number of Standard Deviations to shift the upper and lower bands).
Bollinger recommends using 20 for the number of periods in the moving average and using 2 standard deviations.
He also notes that moving averages of less than 10 do not work very well.
P governs the smoothing of the center line. D controls the width of the upper and lower bands. Narrower bands produce more signals.
FT4Web generates mechanical signals for Bollinger bands using simple rules.
As the red line crosses the upper band moving upward, a sell tic is created. As the red line crosses below the lower band a buy is generated.
These signal rules remove much of the risk (and return) from many issues. DO NOT consider these signals as optimal. Interpretation of Bollinger bands can be considerably more complex.