BB's indicators

Two indicators can be derived directly from Bollinger Bands, %b and Bandwidth.

 

%B

- it tells us where we are in relation to the BBs. 

- it is the key to the development of trading systems via the linking of price and indicator actions. 

 

Bandwidth

- it tells us how wide the bands are. 

- it is the key to the squeeze and can play an important role in spotting the beginnings and ends of trends. 

 

1) %B

 

 

Formula: B

 

The formula evaluates to: 

- 1.0 when the last price is at the upper band

- 0.5 at the middle band

- 0.0 at the lower band.

 

%B is not a bounded formula.

It will exceed 1 when the last price is above the upper band. 

It will fall beneath zero when the last price is below the lower band.

At 1.1 it says that we are 10 percent of the Bandwidth above the upper band. 

At -0.15 it says that we are 15 percent of the Bandwidth below the lower band. 

 

%B allows you to compare the price action within the Bollinger Bands with the action of an indicator, such as a volume oscillator for ex. 

Another important use of %B is to aid pattern recognition. 

We will develop on both these uses later. 

 

%B is a truly relative tool, spinning off no absolute information.

It tells only where we are in relation to the framework created by the Bollinger Bands.

It allows all sorts of relative comparisons. 

 

2) Bandwidth

To calculate Bandwidth --> subtract the lower band from the upper band and then normalize by dividing by the middle band.

Bandwidth can be calculated for any set of bands as long as they are based on a measure of central tendency. 

 

Bandwidth is most useful for identifying the squeeze.

Squeeze --> situation where volatility has fallen to such a low level that its very lowness has become a forecast of increased volatility.

The simplest approach to this is to note when BandWidth is at a six-month low. --> explore later. 

 

An important use of Bandwidth is to mark the beginning of directional trends, either up or down.

Many trends are born in trading ranges when the BandWidth is quite narrow.

A breakout from the trading range that is accompanied by a sharp expansion in BandWidth is often the mark of the beginning of a sustainable trend. 

 

Another important use of Bandwidth is to mark the end of strong trends, themselves often born in Squeezes.

What you'll see is that a strong trend will cause a large expansion in volatility that causes the bands to spread dramatically, so much so that the band on the other side of the trend-e.g., the lower band in an uptrend-will head in the direction opposite to the trend. When that band reverses the move is at an end. This also can be seen and enumerated in BandWidth. The idea is when BandWidth flattens out or turns down enough to reverse the direction of the Bollinger Band on the opposite side of the trend, the trend is at an end. 

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