This would be the last time that Yahoo tested the lower band as it marched upward toward the upper band.
II. Sensitivity Test
This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions. In Spring , Bollinger introduced three new indicators based on Bollinger Bands. Bandwidth tells how wide the Bollinger Bands are on a normalized basis. Writing the same symbols as before, and middleBB for the moving average, or middle Bollinger Band:.
Uses for bandwidth include identification of opportunities arising from relative extremes in volatility and trend identification. The use of Bollinger Bands varies widely among traders. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands.
Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band. 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. One main difference is the keltner channel uses average true range for the calculation. You can use the bollinger band strategy on any time frame but like most trading signals , a higher time frame trade setup is often more reliable. We need to see price moving above the middle line of the bollinger band.
You want to see price pullback into the area of the middle line to initiate a buy signal. You will then look for a price action setup that shows price has a probability of travelling back to the upside. You can also use an opposing trend line break for entry. For selling, we want to see price visit the lower part of the band and either touch or pierce the bands.
From there, price pulls back into the area around the 20 period moving average middle line. The bollinger bands actually have a built in indicator for profit taking: One price has touched the middle line for a buy or sell signal, look for price to travel to the upper or lower band to take your trading profits.
You can also use a Fibonacci measurement for profit taking and trade management. This is a more advanced bollinger band strategy as I am using a combination of technical analysis to trade this chart.
This highlights that while technical indicators such as the bollinger band can aid you in trading, price action will always rule. Bollinger bands can frame price and show you when there is an extreme move worth noting.
Your trading system may require price movement touching or exceeding the upper or lower bands before taking a trade. You can use these as a mean reversion system or a continuation swing trading strategy. The mean reversion aspect is a more advanced bollinger strategy and is shown in the second trade example in the last chart.