|Bollinger Bands, named after market analyst John Bollinger, are a type of trading band indicator that use the standard deviations of a moving average to show a security's trading range. The bands consist of three plotted lines, the middle being a moving average, the upper band being two standard deviations added on to the moving average, and the lower band being two standard deviations subtracted from the moving average. Ninety-eight percent of a security's prices should fall within the band's range. Where any given price falls relative to the bands will indicate whether that security is trading relatively high or low.|
To determine the Bollinger Bands' limits, first calculate the typical price, which is the high, low and close summed and divided by three. Then calculate the 20-day simple moving average. Next, the standard deviation of the typical price over the 20-day period is calculated. The upper Bollinger Band is the 20-day moving average plus two standard deviations. The middle band is the 20-day simple moving average. The lower band is the 20-day simple moving average minus two standard deviations.
|A simple moving average gives the general direction of a security's price, the current price compared to the average, and also filters out noisy data. Statistically an average is a small clue describing a total poplulation of data. You can help describe the security in more depth if you understand how to use the standard deviation along with an average. |
If a security's price average is $50, and its standard deviation is $10, then:
68% of all values will be between $60 and $40, and
96% of all values (+/- two standard deviations from the average), will be between $70 and $30.
|Symantec Corporation (SYMC) has stepped out of its Bollinger Band bounds. This security most likely will retrace to a $60 or lower price level. At that time it may be a less risky buy opportunity.|
|Graphic provided by: CQG.|
|The standard deviation can can help you analyze the following:|
1. Out of bounds data - Data that is likely to be out of bounds will be outside the Bollinger Band limits. Whenever the security price is outside those limits it is implied statistically that the price will only stay outside those upper or lower limits 4% of the time.
2. Security volatility - The larger the standard deviation the higher the volatility.
3. The begining or end of a trend and order execution levels - In some cases the price level may move from one limit end of a Bollinger Band to another showing a possible trend reversal and a possible place to put a buy order, sell order, or sell short order.
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