The Bollinger Bounce.
What is a 'Bollinger Band®' A Bollinger Band® is a set of lines plotted two standard deviations (positively and negatively) away from a simple moving average of the security's price. A Bollinger. Bollinger Bands Overview. I know what you are thinking, "Oh no, not another boring intro on a technical indicator." I created this post to help people learn six highly effective Bollinger Bands trading strategies they could start using immediately.
When the bands lie close together, a period of low volatility is indicated. Traders are often inclined to use Bollinger Bands with other indicators to confirm price action. In particular, the use of oscillator-like Bollinger Bands will often be coupled with a non-oscillator indicator-like chart patterns or a trendline. If these indicators confirm the recommendation of the Bollinger Bands, the trader will have greater conviction that the bands are predicting correct price action in relation to market volatility.
Various studies of the effectiveness of the Bollinger Band strategy have been performed with mixed results. In , Lento et al. The authors did, however, find that a simple reversal of the strategy "contrarian Bollinger Band" produced positive returns in a variety of markets.
Similar results were found in another study, which concluded that Bollinger Band trading strategies may be effective in the Chinese marketplace, stating: A recent study examined the application of Bollinger Band trading strategies combined with the ADX for Equity Market indices with similar results.
A paper from uses Bollinger Bands to reduce variance in a Monte Carlo simulation used to forecast the Canadian treasury bill yield curve. In , Butler et al. Their results indicated that by tuning the parameters to a particular asset for a particular market environment, the out-of-sample trading signals were improved compared to the default parameters.
Companies like Forbes suggest that the use of Bollinger Bands is a simple and often an effective strategy but stop-loss orders should be used to mitigate losses from market pressure. Security price returns have no known statistical distribution , normal or otherwise; they are known to have fat tails , compared to a normal distribution.
Such techniques usually require the sample to be independent and identically distributed, which is not the case for a time series like security prices. Just the opposite is true; it is well recognized by practitioners that such price series are very commonly serially correlated [ citation needed ] —that is, each price will be closely related to its ancestor "most of the time".
Adjusting for serial correlation is the purpose of moving standard deviations , which use deviations from the moving average , but the possibility remains of high order price autocorrelation not accounted for by simple differencing from the moving average.
For such reasons, it is incorrect to assume that the long-term percentage of the data that will be observed in the future outside the Bollinger Bands range will always be constrained to a certain amount. Practitioners may also use related measures such as the Keltner channels , or the related Stoller average range channels, which base their band widths on different measures of price volatility, such as the difference between daily high and low prices, rather than on standard deviation.
Bollinger bands have been applied to manufacturing data to detect defects anomalies in patterned fabrics. The International Civil Aviation Organization is using Bollinger bands to measure the accident rate as a safety indicator to measure efficacy of global safety initiatives. From Wikipedia, the free encyclopedia.
Kirkpatrick and Julie R. Applied Financial Economics Letters. Quarterly Journal of Business and Economics. Bollinger Bands and the ADX". International Federation of Technical Analysts Journal: Particle Swarm Optimization of Bollinger Bands. International Conference on Swarm Intelligence.
There are also some pitfalls of the indicators. In this article, we will address all these areas. Bollinger bands are composed of three lines. One of the more common calculations of Bollinger Bands uses a day simple moving average SMA for the middle band.
The lower band is calculated by taking the middle band minus two times the daily standard deviation. When the price breaks above the upper band, a trader can short the asset betting on a move back to the middle band. Mean reversion assumes that, if the price deviates substantially from the mean, it eventually reverts back to the mean price. In range-bound markets, this technique works well, as prices travel between the two bands like a bouncing ball. During a trend, the trader will constantly be placing trades on the wrong side of the move.
For example, if the trend is down, only take short positions when the upper band is tagged. The lower band can still be used as an exit, if desired, but a new long position is not opened since that would mean going against the trend. Price often can and does "walk the band. This is the reason why they can be very helpful in diagnosing trend. Therefore, the bands naturally widen and narrow in sync with price action , creating a very accurate trending envelope.
The reason for the second condition is to prevent the trend trader from being "wiggled out" of a trend by a quick probative move to the downside that snaps back to the "buy zone" at the end of the trading period.
Note how, in the following chart, the trader is able to stay with the move for most of the uptrend , exiting only when price starts to consolidate at the top of the new range.
The middle band is a simple moving average usually set at 20 periods.
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