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Bollinger Bands | Technical Indicators | BCI Futures

Trading bands are among the most widely used technical indicators. They are lines drawn at fixed intervals (usually a percentage) around a moving average. Bollinger Bands are bands that vary in distance from the moving average based on volatility. The upper band represents x number of standard deviations above the average, and the lower band represents x number of standard deviations below the average. By using standard deviations rather than a fixed percentage, the bands adjust for volatility. During volatile periods, the bands move further away from the average, while during market lulls, the bands move closer to the average.

The closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market.

In practice, the band offsets (standard deviations) should be adjusted to enclose about 90 percent of market activity, with about 10 percent slipping either above or below the Bollinger Bands. This allows for an accurate assessment of the true trading range of the underlying security.

In addition, some traders may want to experiment using a larger offset for the lower band, to allow for the tendency of down trends to be sharper and of shorter duration than up trends. While the conventional usage always has the security rated as either overbought or oversold, a better method is to allow for a neutral reading when prices fall about half way between the upper and lower bands. Applying this method, a security would only be rated as overbought or oversold if it were actually very close to or beyond either the upper or lower band.

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In addition, significant consideration should be given to the price momentum. A security which has entered into overbought or oversold territory may continue to become even more overbought or oversold before reversing. For this reason, look for evidence of price weakness/strength before expecting a reversal.

Reference:

John Bollinger, CFA, President, Bollinger Capital Management, Inc. P.O. Box 3358, Manhattan Beach, CA 90266. Telephone: (310) 798-8855