The defaults today are the same as they were 35 years ago, 20 periods for the moving average with the bands set at plus and minus two standard deviations of the same data used for the average. We'll use the term trading bands to refer to any set of curves that market technicians use to define high or low on a relative basis. The breakout is not a trading signal. A touch of the upper band by price that was not confirmed by strength in the oscillator was a sell setup and a similarly unconfirmed tag of the lower band was a buy setup. Learn how this indicator works, and how you can apply it to your trading. Here are a couple of practical examples of the usage of Bollinger Bands and the classic Bollinger Band tools along with a volume indicator, Intraday Intensity:
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Over the years there have been many variations on those ideas, some of which are still in use. Today the most popular approaches to trading bands are Donchian, Keltner, Percentage and, of course, Bollinger Bands. Percentage bands are fixed, they do not adapt to changing market conditions; Donchian bands use recent highs and lows and Keltner bands use Average True Range as adaptive mechanisms. Bollinger Bands use standard deviation to adapt to changing market conditions and thereby hangs a tale.
When I became active in the markets on a full time basis in I was mainly interested in options and technical analysis. Information on both was hard to obtain in those days but I persisted; with the help of an early microcomputer I was able to make some progress. A touch of the upper band by price that was not confirmed by strength in the oscillator was a sell setup and a similarly unconfirmed tag of the lower band was a buy setup.
The problem with that approach was that percentage bands needed to be adjusted over time to keep them germane to the price structure and the adjustment process let emotions into the analytical process. If you were bullish, you had a natural tendency to draw the bands so they presented a bullish picture, if you were bearish the natural result was a picture with a bearish bias.
This was clearly a problem. We tried reset rules like lookbacks with some success, but what we really needed was an adaptive mechanism. I was trading options at the time and had built some volatility models in an early spreadsheet program called SuperCalc. One day I copied a volatility formula down a column of data and noticed that volatility was changing over time.
Seeing that, I wondered if volatility couldn't be used to set the width of trading bands. That idea may seem obvious now, but at the time it was a leap of faith.
At that time volatility was thought to be a static quantity, a property of a security, and that if it changed at all, it did so only in a very long-term sense, over the life of a company for example. Today we know the volatility is a dynamic quantity, indeed very dynamic. After some experimentation I settled on the formulation we know today, an n period moving average with bands drawn above and below at intervals determined by a multiple of standard deviation We use the population calculation for standard deviation.
The defaults today are the same as they were 35 years ago, 20 periods for the moving average with the bands set at plus and minus two standard deviations of the same data used for the average. I had presented a chart showing an unconfirmed tag of my upper band and explained that the first down day would generate a sell signal. Bill then asked me what I called those lines around the price structure, a question that I was totally unprepared for, so I blurted out the alliteratively obvious choice: They are curves drawn in and around the price structure usually consisting of a moving average the middle band , an upper band, and a lower band that answer the question as to whether prices are high or low on a relative basis.
Bollinger Bands work best when the middle band is chosen to reflect the intermediate-term trend, so that trend information is combined with relative price level data. For many years that was the state of the art: Here are a couple of practical examples of the usage of Bollinger Bands and the classic Bollinger Band tools along with a volume indicator, Intraday Intensity:.
Click chart to enlarge. On 20 July prices tagged the upper Bollinger Band while day Intraday Intensity was deep in negative territory setting up a sell alert.
Any breakout above or below the bands is a major event. The breakout is not a trading signal. The mistake most people make is believing that that price hitting or exceeding one of the bands is a signal to buy or sell. Breakouts provide no clue as to the direction and extent of future price movement.
They are simply one indicator designed to provide traders with information regarding price volatility. John Bollinger suggests using them with two or three other non-correlated indicators that provide more direct market signals.
He believes it is crucial to use indicators based on different types of data. A technical rally is an upward movement in a security's price Buy a bounce is a strategy that focuses on buying a given security A breakout trader is a type of trader who uses technical analysis This strategy has become one of the most useful tools for spotlighting extreme short-term price moves.
Learn how Bollinger's "squeeze" can help you determine breakout direction. In the s, John Bollinger developed the technique of using a moving average with two trading bands above and below it.
Learn how this indicator works, and how you can apply it to your trading. Learn how to successfully trade pullbacks and to avoid being crushed by "falling safes. Learn how to use one of the most popular technical indicators in the MT4 trading platform.
What is a 'Bollinger Band®'
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