Friday, July 20, 2007

Bollinger Bands

Bollinger Bands are a technical trading tool created by John Bollinger in the early 1980s.

The purpose of Bollinger Bands is to provide a relative definition of high and low.
Bollinger Bands consist of a set of three curves drawn in relation to securities prices.

The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper and lower bands.

The interval between the upper and lower bands and the middle band is determined by volatility,typically the standard deviation of the same data that are used for the average.

The default parameters,are 20day (periods) and two standard deviations:

Middle Bollinger Band = 20-Day simple moving average
Upper Bollinger Band = Middle Bollinger Band + 2 * 20-period standard deviation
Lower Bollinger Band = Middle Bollinger Band - 2 * 20-period standard deviation

the interpretation of the Bollinger Bands is based on the fact that the prices tend to remain in between the top and the bottom line of the bands.

A distinctive feature of the Bollinger Band indicator is its variable width due to the volatility of prices.

In periods of considerable price changes (i.e. of high volatility) the bands widen leaving a lot of room to the prices to move in. During standstill periods, or the periods of low volatility the band contracts keeping the prices within their limits.

Calculation
Bollinger bands are formed by three lines. The middle line (ML) is a usual Moving Average.
ML = SUM[CLOSE, N]/N

The top line, TL, is the same as the middle line a certain number of standard deviations (D) higher than the ML.
TL = ML+(D*StdDev)

The bottom line (BL) is the middle line shifted down by the same number of standard deviations.
BL = ML-(D*StdDev)

Where:
N is the number of periods used in calculation;
SMA = Simple Moving Average;
StdDev = means Standard Deviation.
StdDev = SQRT(SUM[(CLOSE-SMA(CLOSE,N))^2,N]/N)

It is recommended to use 20-period Simple Moving Average as the middle line, and plot top and bottom lines two standard deviations away from it.

To Calculate Bollinger Bands of Nifty or Individual stock in MS Excel:.
Column,values to enter, formulas U have to enter
A = Company Name/date
B = Open
C = High
D = Low
E = LTP/close
F = Volumes

first we have to calculate a 20-day standard deviation:

G = here, we have to calculate mean (or Simple Mov. Aver.) of 20 days, we add all 20 days clsoing prices and divide it by 20.i.e no.of periods we require.so in cell G21(20th day) u have to enter formula,it is =SUM(E2:E22)/20

then,we have to manually copy the mean (ie.Simple Mov. Aver.) of 20 days above the G21.till we complete 20 days.ie. G21+19 cells above it.

H = then,we have to calculate deviation for these 20 day period so subract SMA from closing price we get deviation =E2-G2

I = then have to square the deviation so =POWER(H2,2)

J = standard deviation = then,we divide the sum of the squared deviation by the number of days so formula is =SQRT(SUM(I2:I21)/20)

Bollinger bands are formed by three lines.
G = Middle band

K = Upper band (SMA plus 2 standard deviations) =G21+(2*J21)

L = Lower band (SMA minus 2 standard deviations) =G21-(2*J21)

Conclusions
Even though Bollinger Bands can help generate buy and sell signals, they are not designed to determine the future direction of a security.

Bollinger Bands serve two primary functions:
-To identify periods of high and low volatility
-To identify periods when prices are at extreme, and possibly unsustainable, levels.

Remember that buy and sell signals are not given when prices reach the upper or lower bands. Such levels merely indicate that prices are high or low on a relative basis.

A security can become overbought or oversold for an extended period of time.

Finally,the bands are just bands,not signals.A band of the upper Bollinger Band is NOT a sell signal. A bands of the lower Bollinger Band is NOT a buy signal.


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