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. Various studies of the effectiveness of the Bollinger Band strategy have been performed with mixed results.
What is a 'Bollinger Band®'
He was trading options at the time and much of his analytics involved volatility. At the time fixed width trading bands were in use. Bollinger's contribution was to use volatility standard deviation to make trading bands adaptive. When Bollinger first introduced the concept to the public on Financial News Network , they had no name.
During the program, the interviewer pointed to the bands and inquired as to what they were; Bollinger replied "Let's call them Bollinger Bands. The analogy Bollinger uses for Rational Analysis is having multiple tool kits each with different tools.
To get the job done the rational approach is to take the tool that does the job best, regardless of which tool kit it comes from.
The same is true for financial analysis. Depending on the analytical scenario, sometimes technical analysis tools provide the best insights. Sometimes fundamental analysis , behavioral analysis or quantitative analysis ; and most often a combination of all four is the most rigorous and productive. After purchasing his first microcomputer in , Bollinger became involved in the seminal stages of computer-driven technical analysis.
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. The first down day was the sell signal and entry. The red triangle is a negative PowerShift. We have come a long way since the bands were developed. Today we have a suite of Bollinger Bands tools with at least one tool in every major technical analysis indicator category. 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. This strategy has become one of the most useful tools for spotlighting extreme short-term price moves. Learn to pounce on the opportunity that arises when other traders run and hide. Bollinger Bands have become an enormously popular market tool since the s but most traders fail to tap its true potential.
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