Bollinger Bands

Type

Trend indicator

Short introduction

Bollinger bands, named after their inventor John Bollinger, are based on a moving average with an upper and lower band along with the daily movements of the instrument's price The indicator is often used for derivatives. Bollinger Bands are usually abbreviated as "BB".

Statement

Bollinger bands try to capture prices using an upper and lower line. They use a phenomenon known from statistics. Most values are usually close to the mean value, so some outliers "spread out" upwards and downwards. Gauss put this in mathematical form with his normal distribution function.

The mean value is represented by a moving average from which two lines are plotted a standard deviation away in the positive and the negative direction, respectively. The standard deviation indicates the average deviation from this price. The upper Bollinger Band is the MA plus the standard deviation, the lower band is the MA minus the standard deviation. If the standard deviation increases, then the corridor between the bands also increases. Thus, the indicator reacts to an increasing volatility (that is, an annualised standard deviation).

Depending on the intended interpretation, you can contract or widen the corridor by multiplying the standard deviation by a corresponding factor.

Formula/calculation

After constructing a moving average, the following formula applies:

Upper band = MA + s

Lower band = MA - s

where:

s = standard deviation between price and MA

The following MA variants can be used for smoothing via the parameters:

• Simple MA (SMA) - Default setting
• Exponential MA (EMA)
• Weighted MA (WMA)

Interpretation

Due to their statistical basis, the Bollinger Bands actually provide only one result. They bracket the area in which a certain percentage of the prices changes. For one standard deviation, this is about 70%, for a double standard deviation, about 95% of the prices. In addition, it can be assumed that the prices touch the upper or lower edge and then move in the opposite direction.

However, a touched Bollinger Band does not allow us to infer a trading signal. Bollinger Bands are mostly used with other indicators, for example, the MACD. If the price reaches a Bollinger Band and the changes differs between the MACD and the price of the underlying, then we can assume that the price moves again in the direction of the other Bollinger Band.

Default setting

• Basis: 20-Day Moving Average
• Smoothing: MA

• Standard deviation: double
  
  

Example: Bollinger Bands