Bollinger Bands can be applied to any type of chart; however, this indicator works best with daily and weekly charts.
10th October 2013
Earlier last month, Bloomberg reported that Treasury ten year notes snapped a six-day rally-capped by an advance in almost two years- as a technical indicator showed the gain is due to reverse. The ten year yields were sliding below a lower Bollinger band level that suggests the drop in rates is about to end, analysts use the bands to determine a probable range for a rate or security. The surge in U.S. government securities was due to the decision taken by Fed to continue its asset purchases (Q.E) until it found substantial evidence to discontinue the asset purchasing.
What is Bollinger Bands®?
It is a band plotted two standard deviations away from a simple moving average; this was founded by John Bollinger, a long time technician of the markets, who developed the technique of using a moving average with two trading bands above and below it.
How does it work?
The bands widen (move away from the average) and during less volatile periods, the bands contract (move closer to the average). The tightening of the bands is often used by technical traders as an early indication that the volatility is about to increase sharply. Bollinger Bands are one of the most popular technical analysis techniques, the closer the prices move to the upper band, the more overbought the market and closer the prices move to the lower band, the more oversold the market. Traders generally use Bollinger bands to determine overbought and oversold zones, (to confirm divergences between prices and to project price targets). The bands are plotted on a chart at an interval around a moving average- they consist of a moving average and two standard deviations charted as one line above and one line below the moving average. The line above is two standard deviations plotted added to the moving average and the line below is two standard deviations plotted subtracted from the moving averages.
Some traders also use the bands in conjunction with another indicator, such as the Relative Strength Index, (RSI). If the market price touches the upper B-band and the RSI does not confirm the upward move (if there is divergence between the indicators) a sell signal is generated. If the indicator confirms the upward move, no sell signal is generated- a buy signal may be indicated.
Bollinger Bands can be applied to any type of chart; however, this indicator works best with daily and weekly charts. When the bands are applied to a weekly chart, the bonds carry more significance for long term market changes, John Bollinger says the bands do not work well for periods of less than 10 days, he says the optimal period is 20 or 21 days.
How is it calculated?
The interval between upper and lower bands and the middle bands is determined by volatility, the standard deviation calculated from the same data are used for the average. The default parameters are 20 day periods and two standard deviations:
Middle Bollinger band = 20 day simple moving average
Upper Bollinger band = Middle Bollinger band +2 * 20 – period standard deviation
Lower Bollinger band = Middle Bollinger band – 2 *20 – period of standard deviation
Bollinger bands are formed by three lines. The middle line is (ML) is a usual moving average. ML = SUM (Close, N )/N
The top line is same as the middle line except for a certain number of Standard Deviations (D) higher than the ML.
The bottom line is middle line shifted down by the same number of standard deviations
BL = ML-(D*StdDev)
N is the period used in calculation
SMA= Simple Moving Average
StdDev= Standard Deviation