BOLLINGER BANDS

Bollinger Bands, developed by John Bollinger of Bollinger Capital Management, are trading bands that vary in distance from the moving average as a function of a market’s volatility. Bollinger took mathematical formulas commonly used by statisticians to determine the standard deviation of a data series and adapted them for use in calculating the width of trading bands.

Bollinger Bands are usually plotted at an interval of two standard deviations above, and two standard deviations below the moving average for the market studied. Bollinger suggests the optimal period for most applications is 20-21 period average, but it is possible to go as high as 50. A simple Moving Average is most commonly used, but if you want more sensitivity you can use an exponential – for less sensitivity, a smoothed average is ideal.

The original theory was aimed primarily at stocks. Ideally, the bands should be very close together and the chart in a sideways pattern. When price closes outside a band a position is taken in the direction of the breakout. This can be used for breaks up or down. Note that in futures, many more false breaks occur, especially for intraday trading, so you should use another analysis to try and confirm the break.

The formula for computing Bollinger Bands is relatively simple:

Calculate the moving average using the following formula: MA = (P1+ … + Pn)/n

Pn = Price at nth interval

n= Number of periods

Subtract the Moving Average (MA) from each of the data points (p) used in the moving average calculation. This will give you a list of deviations (d) from the average:

Finally, compute the three Bollinger Bands using the following formulas:

Upper Band = MA + 2σ Middle Band = MA

Lower Band = MA -2σ

Bollinger Bands have many uses, including as an exit tool

The bands must be moving in opposite directions indicating trend. In a downtrend the first partial exit is indicated when the top band turns down. This usually occurs as soon as the trend slows and a sideways price movement begins. The second exit occurs when the bottom band turns up. You may not know which exit will yield the best results. If the trend was short-lived or a false breakout, the first exit may still yield a profit. If the trend proves to be vertical, then both bands will continue expanding, indicating you should stay in the move. If the trend proves strong but not explosive, the second exit will work best. Once the first exit is activated your stop is moved to your original entry point.

Bollinger Bands do not give absolute buy or sell signals, but many traders use the following rules:

• Enter the market when one of the bands is penetrated, as this indicates a trend could be starting.
• Exit and reverse your position when the opposite band is penetrated.

BOLLINGER BANDS AUDIO SAMPLE 1

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