Features of the Bollinger Bands

• The bands bounce the market moves back. In other words a market move originating at one band often goes all the way up or down to the other band.
• Sharp market moves happen when the bands contract and approach the average. The longer the period of less volatility then the higher the possibility for a breakout of the bands.
• The breakout of the band means that the current trend is usually maintained.
• A top or a bottom outside the band followed by a top or a bottom inside indicates a trend reversal.

The most commonly used Bollinger bands are drawn two standard deviations away from a 20 period simple moving average. These tuning parameters are usually applied to intermediate-term analysis. However, the number of periods and standard deviations varies. In other words they are “training” or “tuning” parameters of your model.

The above Figure shows how Intel breaks the lower Bollinger band and closes below it on December 22. This presents a clear signal that the Intel stock was oversold. Now Our Bollinger strategy requires a close below the lower band followed by an immediate buy the next day. The next trading day is December 26 (see Figure above). Clearly, it is an excellent trade. December 26 marked the last time Intel would trade below the lower band. From that day forward, Intel climbs all the way until it reaches the upper Bollinger band.

John Bollinger himself states "Choose one that provides support to the correction of the first move up off a bottom. If the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is correctly chosen will provide support far more often than it is broken."

Finally, the Bollinger bands should be used as a measure together with other measures such as the Average Directional Index (ADX), RSI and Stochastic indicators.

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