Tuesday, 07 April 2009 Page 2
Introducing Bollinger Bands
The use of trading bands or price envelopes has a long history and can be traced back to J. Hurst’sThe Profit Magic of Stock Transaction Timing; in which he manually drew smoothed envelopes toaid in cycle identification. In the 1970s, shifted moving averages were increasingly used to identify trend changes and then Bomar Bands, which are constructed in order to contain a fixed percentageof the data, became popular.Bollinger Bands were developed by John Bollinger in the 1980s and unlike other price envelopes use volatility to determine the position of the upper and lower bands. Bolinger Bands use a simplemoving average of price as the centre line. The upper and lower bands are calculated by adding andsubtracting a multiple of the standard deviation of the data. In essence, moving standard deviationsare used to create price bands around a moving average. The standard Bollinger Band uses 2standard deviations, an example is shown below.Bollinger Bands can be used in relation to any length of cycle, using different period movingaverages, however the most commonly used is the 20-day period. When using a different periodmoving average, Bollinger recommended flexing the number of standard deviations used. Forexample it is common to use 2.1 standard deviations for a 50 period moving average while using 1.9standard deviations at 10 periods.