Bollinger Bands (BB) are similar to Envelopes . The difference between them is that the boundaries of the Trading Lanes (Envelopes) are located above and below the moving average curve at a fixed distance expressed in percent, while the Bollinger Bands boundaries are constructed at distances equal to a certain number of standard deviations. Since the magnitude of the standard deviation depends on volatility, the bands themselves adjust their width: it increases when the market is unstable, and decreases in more stable periods.
Bollinger Bands are usually applied to the price chart, but can also be plotted on the chart of the indicator. As in the case of Envelopes, the interpretation of Bollinger Bands is based on the fact that prices tend to remain within the upper and lower boundaries of the band. A distinctive feature of the Bollinger Bands is their variable width, due to price volatility. In periods of significant price changes (ie, high volatility), the bands expand, giving room for prices. In periods of stagnation (ie, low volatility), the bands narrow, keeping prices within their boundaries.
The characteristics of this indicator include:
1. sudden price changes usually occurring after the narrowing of the band, corresponding to a decrease in volatility.
2. If prices exceed the limits of the band, one should expect the continuation of the current trend.
3. If peaks and depressions outside the band are followed by peaks and depressions inside the strip, a reversal of the trend is possible.
4. Price movement, which starts from one of the borders of the strip, usually reaches the opposite boundary.
The latter observation is useful for forecasting price benchmarks.
Calculation of Bollinger Bands – BB
Bollinger bands are formed from three lines. The middle line (MIDDLE LINE, ML) is the usual moving average.
ML = SUM [CLOSE, N] / N
The top line (TOP LINE, TL) is the same middle line, shifted upward by a certain number of standard deviations (D).
TL = ML + (D * StdDev)
The bottom line (BOTTOM LINE, BL) is the middle line, shifted down by the same number of standard deviations.
BL = ML – (D * StdDev)
SUM (…, N) – the sum for N periods;
CLOSE – the closing price;
N is the number of periods used for the calculation;
SMA – simple moving average;
SQRT is the square root;
StdDev is the standard deviation:
It is recommended to use a 20-period simple moving average as the midline and 2 standard deviations for calculating the band boundaries. In addition, moving averages of less than 10 periods are ineffective.