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Bollinger Bands is the indicator that resembles Envelopes Indicator very much except that Envelopes has boundaries that are above and below the moving average, and they are fixed at a certain interest level; Bollinger Bands has them fixed at the distance of a certain number of standard deviations that depend on volatility: in case of instability, the distance grows, in case of stability it goes down.
Bollinger Bands can be both applied to the indicator chart and on price chart. The peculiarity of the bands is holding price within the boundaries of upper and lower indicator limits. In case if instability bands spread out allowing more space for prices to move; when there is a standstill, bands come closer.
It is after bands come closer active price changes occur, and when prices stretch beyond their limit the tendency continues. The trend may turn around if peaks and troughs beyond the band boundary are followed by peaks and troughs inside the band. It is also important for making predictions regarding price guidelines for price movement from one extreme band to reach the opposite boundary.
Indicator calculation technique
Bollinger Bands are made of three lines. Average middle (MIDDLE LINE, MID) is a simple moving average.
MID = S (CL, X) / X = SMA (CL, X)
Upper line (TOP LINE, TOP) is an upward moving average shifted to a certain number of standard deviations (Y).
TOP = MID + (Y * SD)
Bottom line (BOTTOM LINE, BOT) is an downward moving average shifted to the same number of standard deviations.
TOP = MID – (Y * SD)
Where:
S (X) is the sum per X time intervals;
X is the number of time intervals used for calculations;
CL is closing price;
SQRT is square root;
SMA is a simple moving average;
SD is a standard deviation;
SD = SQRT (S ((CL – SMA (CL, X))^2, X)/X).
Related: Technical Analysis – Price Action Trading (Part 3)
It is better to use two standard deviations and 20period simple moving average as the middle line for the calculation of band boundaries. When the length is below 10 periods, moving average lines have poor efficiency.
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