INDICATORS. Bollinger Bands.

12 Nov

Bollinger Bands developed by John Bollinger are volatility bands placed above and below a moving average. The bands are based on standard deviation (SD), which is a function of a currencies volatility. Bollinger Bands widen when volatility increases and narrow when volatility decreases. Settings for the Bollinger Bands can be adjusted to suit the particular characteristics of the currency being analyzed. Bollinger recommends making small incremental upward adjustments to the standard deviation multiplier when the number of periods is increased, since longer time periods will result in a smaller SD (with all other factors held constant). With a 20-day SMA and 20-day SD, the SD multiplier is set at 2.0. Bollinger suggests increasing the SD multiplier to 2.1 for a 50-day SMA and decreasing the SD multiplier to 1.9 for a 10-day SMA.

How to trade signals.

W- Bottoms – Bollinger uses various W patterns with Bollinger Bands to identify W-Bottoms (based on the work of A. Merrill). A “W-Bottom” forms in a downtrend and involves two reaction lows. Bollinger looks for these bottoms where the second low is lower than the first, but holds above the lower band. Four steps are required to confirm a W-Bottom with Bollinger Bands:

• A reaction low forms. This low is normally, but not always below the lower band;

• The price experiences an upward move towards the middle band;

• A new price low is reached holding above the lower band;

• The pattern is confirmed with a move off the second low breaking resistance.

M-Tops – Bollinger uses the various M patterns identified in Merrill’s work to signal market tops. Bollinger asserted that market tops are often more complicated and drawn out than bottoms, and can be signalled by double tops, head-and-shoulder patterns and diamonds. A basic M top is similar to a double top, although reaction highs are often not equal and the first high can be higher or lower than the second high. A classic M top should play out as follows:

• A reaction high breaches the upper band;

• A pullback occurs towards the middle band;

• The price moves to above the prior high, but fails to reach the upper band;

• Final confirmation of a topside failure will come with a support break or other bearish indicator signal.

Follow the bands.

Moves above or below the Bands should not be construed as signals, rather Bollinger called such moves that touch or exceed the Bands as “tags”. During strong up-trends/down-trends prices will touch the band numerous times, Bollinger called this “walking the band” and can be taken as a sign as significant strength or weakness, conditions which can persist during trends. It is common for prices to not reach the other side of the band during these strong trends until a reversal is under way, an upper band touch that occurs after a Bollinger Band confirmed W-Bottom would signal the start of an uptrend.

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