Bollinger Band Width
Bollinger Band Width is closely related to John Bollinger's original Bollinger Bands indicator. The Bollinger Band Width indicator is a measure of the difference between the upper band and the lower band. The indicator value decreases as the distance between the two bands narrows and increases as the distance between the two bands widens. Since Bollinger Bands are based on a measure of standard deviation, a decreasing value for the bandwidth relates to decreasing volatility while an increasing value for the bandwidth means volatility is increasing.
Bollinger Band Width is calculated using the following formula: (Upper Band - Lower Band)/Middle Band
First, the value of the lower band is subtracted from the value of the upper band and then divided by the value of the middle band to normalize the result. The indicator can then be easily measured against previous readings, making it possible to recognize changes in the volatility structure of the security being studied.
Using the Bollinger Band Width indicator
Volatility, like price, goes through periods of expansion and contraction. The Bollinger Band Width is a particularly valuable tool when volatility contracts.
Remember that when the indicator readings are very low a narrowing of the Bollinger Bands has occurred, meaning that price volatility has reached a very low level. This low reading often precedes a sharp expansion in volatility highlighted by aggressive price movement. While the low indicator reading doesn't predict which direction prices might break out, the eventual breakout may in fact be the start of a significant directional move that the trader can exploit. The chart illustration shown below is based on a 20-period moving average and 2 standard deviations, which is the default value for the indicator. Low readings on the indicator are often followed by sharp price moves.
For a more sensitive indicator, the settings can be adjusted accordingly to generate more frequent signals of extremes in volatility. In the next chart, the settings have been changed to a 5-period moving average and 4 standard deviations. As seen in the indicator, the frequent extreme low readings are generally consistent with a contraction in price and often precede a sharp price move. Note too that when using a shorter moving average upward spikes in the indicator can coincide with the termination of these sharp short-term price swings. This is the same chart as above but, by using the shorter-term settings, the indicator picks up those shorter-term price contractions that in turn set up more potential trading opportunities.
The analytical tools described in this article are for information purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision.
Any specific securities, or types of securities, shown are for demonstration purposes only and should not be considered investment advice. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision