For example, the Utilities SPDR (XLU) represents utility stocks, which have relatively low volatility. The Technology SPDR (XLK) represents technology stocks, which have relatively high volatilities. Because of lower volatility, XLU will have consistently lower BandWidth values than XLK. The 200-day moving average of XLU BandWidth is below 5, while the 200-day moving average of XLK BandWidth is above 7. The upper and lower bands are typically two standard deviations from the SMA.
- Because Bollinger Bands are based on the standard deviation, falling BandWidth reflects decreasing volatility, and rising BandWidth reflects increasing volatility.
- Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA.
- Once you identify the squeeze, it’s time to watch for a breakout above the upper band, indicating an upward trend, or a break below the lower band, hinting at a downward trend.
- The time period to be used in calculating the SMA which creates the base for the Upper and Lower Bands.
(Price envelopes define upper and lower price range levels.) Bollinger Bands are envelopes plotted at a standard deviation level above and below a simple moving average of the price. Because the distance of the bands is based on standard deviation, they adjust to volatility swings in the underlying price. John Bollinger developed the Bollinger band indicator which is based on the volatility as standard deviation. Bollinger Band calculates deviation as the square root of the variance.
Double bottom refers to the fact that the market index’s intraday prices are low, as well as a low Bollinger Band Width, which can both be indicators that the index may be oversold. If you anticipate a rebound, you might purchase stocks at a relatively discounted rate, hoping to profit if the index rebounds. For example, a high BBW indicates a high level of volatility, while a narrow one shows that prices remain relatively close to the moving average. When using Bollinger Bands®, designate the upper and lower bands as price targets. If the price deflects off the lower band and crosses above the 20-day average (the middle line), the upper band comes to represent the upper price target.
How to Interpret Bollinger Bands Width?
Note, however, that counter-trend trading requires far larger margins of error, as trends will often make several attempts at continuation before reversing. To help remedy this, a trader can look at the overall direction of price and then only take trade signals that align the trader with the trend. 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. Many technical indicators work best in conjunction with other ones.
Looking at the increase in volatility or higher Bollinger Bandwidth value on the USD/JPY daily chart, it shows USD/JPY reaching new lows outlined by the square boxes. This parabolic movement in price and rising volatility does hint at a potential trend reversal (to the upside in this case). The highlighted portion on the chart and Bollinger Bandwidth indicator signifies low volatility and a period of consolidation (sideways movement).
- They are used in pairs, both upper and lower bands and in conjunction with a moving average.
- Normalized Bollinger BandWidth is shown in the Market Carpet, allowing users to compare BandWidth for a number of securities.
- This scan reveals stocks whose Bollinger Bands just expanded rapidly after being contracted for 5 or more days.
Yes, but it’s crucial to note that securities with lower volatility will naturally have lower BandWidth values than those with higher volatility. For instance, utility stocks generally have lower BandWidth values than technology stocks. bollinger bands bandwidth This scan reveals stocks whose Bollinger Bands just expanded rapidly after being contracted for 5 or more days. When calculating BandWidth, the first step is to subtract the value of the lower band from the value of the upper band.
Bollinger Band Width Indicator
In a strong uptrend, prices usually fluctuate between the upper band and the 20-day moving average. When that happens, a cross below the 20-day moving average warns of a trend reversal to the downside. When the price breaks through the upper or lower band, the trader buys or sells the asset, respectively. A stop-loss order is traditionally placed outside the consolidation on the opposite side of the breakout. Bollinger Band® “bands” can also be a valuable tool for traders who like to exploit trend exhaustion by helping to identify the turn in price.
Signal: The Squeeze
Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.
Examples of Bollinger Bands®
BandWidth decreases as Bollinger Bands narrow and increases as Bollinger Bands widen. Because Bollinger Bands are based on the standard deviation, falling BandWidth reflects decreasing volatility, and rising BandWidth reflects increasing volatility. The Bollinger Bands Width is an extension of the Bollinger Bands Indicator, both of which are useful technical indicators to identify The Squeeze and its resultant volatility. The market often tells you when a period of high volatility (trading opportunities) is about to begin after The Squeeze.
In the first instance, the low period of consolidation was marked by a strong breakout in prices. Technical analysis focuses on market action — specifically, volume and price. When considering which stocks to buy or sell, you should use the approach that you’re most comfortable with. The Bollinger Bandwidth indicator illustrates periods of varying volatility relative to the market price movement. The chart below shows how volatility falls when the Bollinger Band® width contracts and rises when the width expands. After periods of consolidation (low volatility), it is often noted that price tends move in an asserted fashion either up or down.
They are plotted as two standard deviations, both positively and negatively, away from a simple moving average (SMA) of a security’s price and can be adjusted to user preferences. Derived from Bollinger Bands, the BandWidth indicator is a tool to identify periods of low and high market volatility. This, in turn, can give you some insight into potential market movements. The condition known as “The Squeeze” happens when the BandWidth is at a historically low level, suggesting that a significant price move is imminent, more or less.
You can jump onboard the trend with a close stop below the most recent low. As you can see, the low points do not predict which way the market is going to break. You will need to use other analysis techniques to identify your edge. In the second scenario, the low bandwidth reading called the short-term top and subsequent price selloff. Traders can trade with the Bollinger Bandwidth indicator in several different ways but two of the most common ways to trade with this indicator involve breakout and reversal movements.
Over the Counter (OTC) Stock Trading Explained
At the core, Bollinger Bands® measure deviation, which is why the indicator can be very helpful in diagnosing trend. By generating two sets of Bollinger Bands®, one set using the parameter of “one standard deviation” and the other using the typical setting of “two standard deviations,” we can look at price in a whole new way. The first step in calculating Bollinger Bands® is to compute the simple moving average (SMA) of the security, typically using a 20-day SMA. A 20-day SMA averages the closing prices for the first 20 days as the first data point. The most common way to trade with the Bollinger bandwidth indicator is breakouts. As previously discussed, low periods of volatility precede high periods of volatility.