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Bollinger Bands consist of a Moving Average and two standard deviations charted as one line above and one line below the Moving Average. The line above is two standard deviations added to the Moving Average. The line below is two standard deviations subtracted from the Moving Average. Developed by John Bollinger, this study represents a variation of the Envelope study.
Period: John Bollinger, the creator of this study, states that periods of less than ten days do not seem to work well for Bollinger Bands. He says that the optimal period is 20 or 21 days. The application uses a default of 20.
Standard Deviation: The multiple of standard deviations by which to shift the upper and lower bands. The application uses a default of 2.0
Aspect: The Symbol field on which the study will be calculated. Field is set to “Default”, which, when viewing a chart for a specific symbol, is the same as “Close”.
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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.
Note: The Bollinger Band study was created by John Bollinger, President of Bollinger Capital Management, Inc. For more information about Bollinger Bands or John Bollinger’s Capital Growth Letter, You may write:
John Bollinger’s Capital Growth Letter
P.O. Box 3358
Manhattan Beach, CA 90266
Content Source: FutureSource