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Bollinger BandWidth (BBW)

Definition

Bollinger BandWidth (BBW) is a technical analysis indicator derived from the standard Bollinger Bands indicator. Bollinger Bands are a volatility indicator which creates a band of three lines which are plotted in relation to a security's price. The Middle Line is typically a 20 Day Simple Moving Average. The Upper and Lower Bands are typically 2 standard deviations above and below the SMA (Middle Line). Bollinger BandWidth serve as a way to quantitatively measure the width between the Upper and Lower Bands. BBW can be used to identify trading signals in some instances.

History

The creator of Bollinger Bands, John Bollinger, introduced Bollinger BandWidth in 2010 almost 3 decades after the introduction of his Bollinger Bands.

Calculation

Bollinger BandWidth = (Upper Band - Lower Band) / Middle Band * 100

The basics

Bollinger BandWidth (BBW) uses the given calculation and outputs a Percentage Difference between the Upper Band and the Lower Band. This value is used to define the narrowness of the bands. What needs to be understood however is that a trader cannot simply look at the BBW value and determine if the Band is truly narrow or not. The significance of an instruments relative narrowness changes depending on the instrument or security in question. What is considered narrow for one security may not be for another. What is considered narrow for one security may even change within the scope of the same security depending on the timeframe. In order to accurately gauge the significance of a narrowing of the bands, a technical analyst will need to research past BBW fluctuations and price performance to increase trading accuracy.

What to look for

The Squeeze

One of the most well-known theories in regards to Bollinger Bands is that volatility typically fluctuates between periods of expansion (Bands Widening) and contraction (Bands Narrowing). With this in mind, the major trading signal generated by Bollinger BandWidth is known as The Squeeze.

The Squeeze setup is very straightforward and consists of two steps:

  1. There is a period of low volatility. The means that the bands are narrow and price is moving relatively sideways.
  2. The low volatility period is followed by a surge in volatility and price breaks through the Upper Band or falls through the Lower Band signifying a change in the sideways movement and the beginning of a new directional trend.

In a Bullish BBW Squeeze:

  1. BBW drops.
  2. Price breaks through the Upper Band which starts a new upward trend. Volatility also increases.

In a Bearish BBW Squeeze:

  1. BBW drops. (In the example below, the threshold is 9% however this changes from security to security and timeframe to timeframe).
  2. Price falls below the Lower Band which starts a new downward trend. Volatility also increases.

Summary

Bollinger BandWidth (BBW) be quite a useful technical analysis tool for identifying "The Squeeze" which can result in some nice buying or selling signals. Of course the trader should always use caution. Sometimes the breakout after a Squeeze setup has an immediate pullback and the rally never happens. It takes a trader's better judgment to really determine if the breakout is a strong, legitimate one. That being said, when a strong uptrend or downtrend after a Squeeze does occur it provides a great opportunity for the prepared analyst or trader.

 

Inputs

Length

The time period to be used in calculating the SMA which creates the base for the Upper and Lower Bands. 20 days is the default.

Source

Determines what data from each bar will be used in calculations. Close is the default.

StdDev

The number of Standard Deviations away from the SMA that the Upper and Lower Bands should be. 2 is the default.

Highest Expansion Length

The Highest Expansion plot displays the highest value that BBW had in the last N bars, where N is the length specified by this input.

Lowest Contraction Length

The Lowest Contraction plot displays the lowest value that BBW had in the last N bars, where N is the length specified by this input.