Bollinger Band Interpretations
Bollinger Bands consist of a middle band with two outer bands.
The middle band is a simple moving average that is usually set at 20 periods.
A simple moving average is used because the standard deviation formula also uses a simple moving average. The look-back period for the standard deviation is the same as for the simple moving average.
The outer bands are usually set 2 standard deviations above and below the middle band. Settings can be adjusted to suit the characteristics of particular securities or trading styles. Bollinger recommends making small incremental adjustments to the standard deviation multiplier.
Changing the number of periods for the moving average also affects the number of periods used to calculate the standard deviation. Therefore, only small adjustments are required for the standard deviation multiplier.
An increase in the moving average period
An increase in the moving average period would automatically increase the number of periods used to calculate the standard deviation and would also warrant an increase in the standard deviation multiplier. With a 20-day SMA and 20-day standard deviation, the standard deviation multiplier is set at 2. Bollinger suggests increasing the standard deviation multiplier to 2.1 for a 50-period SMA and decreasing the standard deviation multiplier to 1.9 for a 10-period SMA.
W-Bottoms were part of Arthur Merrill’s work that identified 16 patterns with a basic W shape. Bollinger uses these various W patterns with Bollinger Bands to identify W-Bottoms, which form in a downtrends and contain two reaction lows. In particular, Bollinger looks for W-Bottoms where the second low is lower than the first but holds above the lower band.
There are four steps to confirm a W-Bottom with Bollinger Bands. First, a reaction low forms. This low is usually, but not always, below the lower band. Second, there is a bounce towards the middle band. Third, there is a new price low in the security. This low holds above the lower band. The ability to hold above the lower band on the test shows less weakness on the last decline. Fourth, the pattern is confirmed with a strong move off the second low and a resistance break.
moving average period & Bollinger Band Interpretations
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