This article describes Bollinger Bands, the indicators %b and Bandwidth and discusses how to use them when making trading decisions

1.
MoneyVidya.com Investor Essentials:
Introducing Bollinger Band Indicators: Bandwidth and %b
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2.
Introducing Bollinger Bands
The use of trading bands or price envelopes has a long history and can be traced back to J. Hurst’s
The Profit Magic of Stock Transaction Timing; in which he manually drew smoothed envelopes to
aid in cycle identification. In the 1970s, shifted moving averages were increasingly used to identify
trend changes and then Bomar Bands, which are constructed in order to contain a fixed percentage
of the data, became popular.
Bollinger Bands were developed by John Bollinger in the 1980s and unlike other price envelopes use
volatility to determine the position of the upper and lower bands. Bolinger Bands use a simple
moving average of price as the centre line. The upper and lower bands are calculated by adding and
subtracting a multiple of the standard deviation of the data. In essence, moving standard deviations
are used to create price bands around a moving average. The standard Bollinger Band uses 2
standard deviations, an example is shown below.
Bollinger Bands can be used in relation to any length of cycle, using different period moving
averages, however the most commonly used is the 20-day period. When using a different period
moving average, Bollinger recommended flexing the number of standard deviations used. For
example it is common to use 2.1 standard deviations for a 50 period moving average while using 1.9
standard deviations at 10 periods.
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3.
Indicators Derived from Bollinger Bands
There are two commonly used secondary indicators which can be derived from Bollinger Bands, %b
and BandWidth.
%b measures where within the bands the observed price sits; 100% indicates the current price is
touching the upper band upper band, 0% the lower band.
%
Tagging the bottom band (%b=0) is an indication that current price is unusually low, and is
generally thought to be a bullish signal. Similarly the tagging of the upper band (%b=100) is an
indication that the current price is unusually high and is generally thought to be a bearish signal.
Band width, another indicator derived from Bollinger Bands, measures the width of the bands as a
percent of the moving average;
A low bandwidth implies that volatility of prices has been low in recent periods and therefore that
prices have been trading in a tight range. A small or declining bandwidth can be an indicator of an
upcoming breakout in price if the temporary equilibirum between buyers and sellers fails to hold.
As Bollinger Bands are a common in modern charting packages, visual observation of narrowing
bands can serve as well as measuring the Bandwidth, similarly one can easily see how close to the
upper or lower bands the current price is without calculating %b.
Using Bollinger Bands to derive trading signals
Although tagging the bottom band is an indication that current price is unusually low, this should
not in itself generate a buy signal unless the bullish sentiment is confirmed by another indicator,
similarly the tagging of the upper band does not in itself constitute a sell signal unless confirmed.
The choice of confirming indicator is important and as the Bollinger Bands are a function of price,
care should be taken when using a price indicator to confirm, RSI or MACD are among the best
choices. Appropriate confirming indicators can also be derived from momentum, volume, sentiment
or a combination of price and volume such as on-balance volume (OBV) or Chaikins Money Flow.
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