Bollinger Bands

Developed by John Bollinger, Bollinger Bands allows users to compare volatility and relative

Price levels over a period time. Bollinger Bands are envelopes which surround the price bars on a

Chart. They are plotted two standard deviations away from a simple moving average. Because

Standard deviation is a measure of volatility, the bands adjust themselves to ongoing market

Conditions. They widen during volatile market periods and contract during less volatile periods.

Bollinger Bands are, essentially, moving standard deviation bands.

 

Bollinger Bands are sometimes displayed with a third center line. This is the simple moving

average line. Mr. Bollinger recommends using a 10 day moving average for short term trading,

20 days for intermediate term trading, and 50 days for longer term trading.

 

The standard deviation value may be varied. Increase the value of the standard deviation from 2

standard deviations to 2-1/2 standard deviations away from the moving average when using a 50

day moving average. Conversely, lower the value of the standard deviation from 2 to 1-1/2

standard deviations away from the moving average when using a 10 day moving average.

 

Bollinger Bands do not generate buy and sell signals alone. They should be used with another

indicator. I use them with RSI, described below. This is because when price touches one of the

bands, it could indicate one of two things. It could indicate a continuation of the trend; or it could

indicate a reaction the other way. By themselves they do not tell us when to buy and sell.

 

However, when combined with an indicator such as RSI, they become powerful. RSI is an

excellent indicator with respect to overbought and oversold conditions. When price touches the

upper band, and RSI is below 70, we have an indication that the trend will continue. When price

touches the lower band, and RSI is above 30, we have an indication that the trend will continue.

 

If we run into a situation where price touches the upper band and RSI is above 70 (possibly

approaching 80) we have an indication that the trend may reverse itself and move downward. On

the other hand, if price touches the lower band and RSI is below 30 (possibly approaching 20) we

have an indication that the trend may reverse itself and move upward.

 

Avoid using several different indicators all using same input data. If you’re using RSI with the

Bollinger Bands, don’t use MACD too. They both use the same inputs. Consider using On

Balance Volume, or Money Flow with RSI. Relying on different inputs they measure different

things. They can be used together as further confirmation of a trend.

 

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