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Definition of 'Bollinger Bands'


Definition: Bollinger Bands is one of the popular technical analysis tools, where three different lines are drawn, with one below and one above the security price line. Its specific period moving average is denoted as midline to form an ‘envelope’. These lines show a band or a volatility range in which a particular security price is moving up or down. Volatility is shown on the basis of standard deviation for a particular security, which is denoted by upper and lower line/band, as standard deviation is a measure of volatility. Bollinger Bands was developed by John Bollinger in the mid 1980s and he trademarked this term in 2011. Initially, it was called trading bands, but later on, John Bollinger evolved this concept and called it Bollinger Bands.

Description: Bollinger Bands shows the levels of different highs and lows that a security price has reached in a particular duration and also its relative strength, where highs are near to the upper line and lows are near to lower line. In other words, the price points near the edges of the ‘envelope’ formed can help us recognise a pattern at a particular moment. The bandwidth widens and narrows depending on volatility. If it’s high, the band would widen and if the volatility decreases, then the band would narrow. These bands show oversold and overbought conditions in relation to a selected time period moving average.

Bollinger Bands are somewhat like moving average envelopes, but drawing calculations for both is different. In Bollinger Bands, standard deviation levels are considered to draw the upper and lower lines, whereas for Moving Average Envelopes, the lines are plotted by taking a fixed percentage.

Calculation: For calculation of Bollinger Bands, the following variables are required:

a) Time Period denoted -- ‘N’

b) Standard Deviation value -- ‘s’

c) Three Bollinger bands or lines where:

1. Moving Average Line or Middle Band for ‘N’ period MA (N). Refer average ‘Moving Average’ concept for calculation

2. Upper Band or line wherein MA line is shifted up by price standard deviation for ‘N’ period multiplied by SD measure value ‘D’ (MA + D(s))

3. Lower Band or line where in MA line is shifted below by price standard deviation for ‘N’ period multiplied by SD measure value ‘D’ (MA – D(s))

For different securities, different variable settings can be chosen. Typically traders use 20-day simple moving average with a standard deviation of 2. Some traders may use exponential moving average too.

Example: Taking normal parameters used for drawing Bollinger Bands, we choose:

· Security: Nifty 50

· Data set: Daily close value

· Moving Average: 20-Day simple moving average

· Standard Deviation measure value (D): 2

· Standard Deviation for price calculated for 20-day period

· Filled Range

· Here the green line is the upper band, showing standard deviation above the moving average, which is a 20-day simple MA + (20-Day SD of price x 2)

· The blue line is middle band showing 20-day simple MA

· The red line is lower band showing standard deviation below moving average, which is the 20-day simple MA + (20-Day SD of price x 2)


http://economictimes.indiatimes.com/markets/technical-charts

The band was widest when Nifty50 was volatile during July, the band narrowed when Nifty50 was consolidating during September.

Some important points for interpretation of Bollinger Bands:

· When bands are contracting, there are chances of sharp price changes as volatility is drops

· When price line surpasses the bands’ range, that a strong signal of continuation of the current trend

· When new highs and lows are made outside the bands followed by highs and lows made inside the bands, it shows an imminent trend reversal

· If a move originating in one band tends to replicate on the other band too, it is useful in deciding future price targets

· When the price moves near the upper band, that shows an overbought market, and when the prices are nearer to the lower band, that signals an oversold market

· M-patterns is one of the signal created by Arthur Merrill as an extension to Bollinger Bands to identify M-Tops, which shows signs of confirmation when prices are making new highs

· W-Bottoms, again Arthur Merrill’s work to identify W-Bottoms to determine the strength when prices are making new lows

· Use of Bollinger Bands varies with different traders. Some traders may buy when price are near the lower Bollinger Bands

· Traders tend to exit when price line touches the middle line

· Traders may buy when the price line breaks above the upper band and sell when price falls below the lower band



Source YouTube channel: Renegadetrader
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Copyright © 2019 Bennett, Coleman & Co. Ltd. All rights reserved. For reprint rights: Times Syndication Service

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