Bollinger Bands

Overview

Bollinger Bands were developed by John Bollinger and introduced in the late 1980's. Bollinger Bands serve these primary functions:

* To provide a relative definition of high and low

* To identify periods of high and low volatility

* To identify periods when prices are at extreme levels

They do this by using standard deviation as a measure of volatility. Since standard deviation is a measure of volatility, the bands are self-adjusting; They widen during periods of higher volatility and contract during periods of lower volatility. Bollinger Bands consist of 3 bands designed to emcompass the majority of a trading instrument's price action. The middle band is a basis for the intermediate-term trend, typically a 20-periods simple moving average, that also serves as the base for the upper and lower bands. The upper band's and lower band's distance from the middle band is determined by volatility. Typically, the upper band is plotted +2 standard deviations above the middle band while the lower band is plotted -2 standard deviations below the middle band.

Interpretation

Bollinger Bands are usually calculated using the trading instrument's prices, but they can also be calculated using other indicators as their base. These comments refer to bands displayed on prices. Mr. Bollinger notes the following characteristics of Bollinger Bands.

* Sharp price changes tend to occur after the bands tighten as volatility lessens (a.k.a. "the Squeeze")

* When prices move outside the bands a continuation of the current trend is implied

* Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend

* A move that originates at one band tends to go all the way to the other band

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