Bollinger Bands Technical Indicator (BB) is similar to
Envelopes.
The only difference is that the bands of Envelopes are plotted a
fixed distance (%) away from the
moving average, while the Bollinger
Bands are plotted a certain number of standard deviations away from it.
Standard deviation is a measure of volatility, therefore Bollinger Bands
adjust themselves to the market conditions. When the markets become more
volatile, the bands widen and they contract during less volatile periods.
Bollinger Bands are usually plotted on the price chart, but they
can be also added to the indicator chart (Custom Indicators). Just
like in case of the Envelopes,
the interpretation of the Bollinger Bands is based on the fact that the
prices tend to remain in between the top and the bottom line of the bands.
A distinctive feature of the Bollinger Band indicator is its variable width
due to the volatility of prices.
In periods of considerable price changes (i.e. of high volatility)
the bands widen leaving a lot of room to the prices to move in. During
standstill periods, or the periods of low volatility the band contracts
keeping the prices within their limits.
The following traits are particular to the Bollinger Band:
abrupt changes in prices tend to happen after the band
has contracted due to decrease of volatility.
if prices break through the upper band, a continuation
of the current trend is to be expected.
if the pikes and hollows outside the band are followed by
pikes and hollows inside the band, a reverse of trend may occur.
the price movement that has started from one of the band’s
lines usually reaches the opposite one. The last observation is useful
for forecasting price guideposts.
Calculation
Bollinger bands are formed by three lines. The
middle line (ML) is a usual Moving Average.
ML = SUM [CLOSE, N]/N
The top line, TL, is the same as the middle line a
certain number of standard deviations (D) higher than the ML.
TL = ML + (D*StdDev)
The bottom line (BL) is the middle line shifted down by
the same number of standard deviations.
BL = ML — (D*StdDev)
