Bollinger Bands, which were developed by John Bollinger of Bollinger Capital Management, are trading bands based on a measure of volatility of recent price action. Bollinger used two standard deviations of closing prices and plotted the values above and below a simple moving average. The standard parameters for Bollinger Bands use a 20-bar simple moving average, and the trading bands are lines plotted two standard deviations above and below the moving average. The use of Bollinger Bands can be improved by a simple modification through CQG, which will be explained after this overview of the classic approach.
The trading bands tend to capture approximately 90% of the price data, less than the approximate 95% that should occur if markets did not demonstrate a higher than normal degree of variance from the average.
The standard deviation measures the degree of variance around a moving average: First, by calculating the difference between the closing price and the moving average for each close in the lookback period, and second, by squaring it to remove the negative values, then calculating the average of the squared differences, and finally, the square root of the average.
Therefore, if the closing prices start moving away from the average price, the Bollinger Bands will expand, and if the closing prices begin to trade around the moving average, the Bollinger Bands will contract.
Traders will vary the length of the moving average and number of standard deviations (between 1.9 and 2.1), based on how often they want trading signals.
Techniques
This tendency to contract and expand is the primary value of the Bollinger Bands. Market trends tend to emanate from low periods of volatility, which appears as sideways movement on the price chart. When a market moves in a narrow range, the Bollinger Bands will contract because the closing prices are grouped around the average price.
Often, the market is marking time, waiting for some news such as a key economic statistic. When the news is announced, the market can move into a sustained trend.
The value of the Bollinger Bands is that you can identify low-volatility situations, which then can be used as a condition in CQG (for example, the difference between the upper and lower Bollinger Bands has dropped below a certain threshold), use the condition to mark a chart or as an alert, a component to a custom study, or as a rule in a trading system for further analysis. This condition could also be used for CQG’s Market Scan to find low-volatility situations.
The other side of the coin is the tendency for Bollinger Bands to expand during a trend. In fact, the first start of a trend will cause the two Bollinger Bands to move in the opposite direction. This expansion confirms the trend. As the market trends though, any deceleration in momentum will cause the Bollinger Band heading away from the trend to turn toward the trend. This is the first sign of loss of momentum, and a reason to exit or take partial profits on a trade.
Next, both Bollinger Bands will begin to contract, alerting you to a trading range beginning, and giving you a reason to exit the entire trade. Both of these events may be the basis for a CQG condition, alert, custom study, or rule in a trading system.
One challenge with Bollinger Bands is you must wait for the bar to close before you can determine the final value of the Bollinger Band. In other words, the value of the Bollinger Band is fluctuating with the live bar.
If the market is surging upward, the upper Bollinger Band will be rising and may be above the high of the current bar. If the market reverses and closes mid-range in the bar, the high may now be tagging the upper Bollinger Band, but that is due to the close being well below the high. The high was not tagging the upper Bollinger Band when the high actually occurred.
Looking back over charts, you can see that there are obvious points where a breakout of the Bollinger Band signaled a trend or a tag of the band that marked the end of the trend. But you would not know if this was the case while the bar was live because the Bollinger Band was moving with the price. You do not have a fixed frame of reference.
With CQG, you can easily create a custom study that creates a fixed frame of reference based on the Bollinger Bands.
Advanced Bollinger Bands
Instead of using Bollinger Bands as a live calculation of the current bar, set the Bollinger Bands to be a fixed frame of reference by creating a custom study using CQG’s Formula Editor. Create a custom study for the high Bollinger Band and a study for the low Bollinger Band using the lookback period of your choice, but click on time and select offset –1. The custom-study, advanced Bollinger Bands are plotting the previous value of the Bollinger Band on the current live bar, providing you with a fixed frame of reference.
The advanced Bollinger Bands can be used as support and resistance levels. The Bollinger Band is a fixed price to key off of for the current bar. Breakouts of the advanced Bollinger Bands indicate that the market is moving past previous levels that contained the price action. A breakout that reverses back between the advanced Bollinger Bands will signal a false breakout.
One other aspect of the advanced Bollinger Bands is they are not obvious support and resistance levels, such as the previous day’s high or low, which can be traps for traders.
The advanced Bollinger Bands can be used in CQG as a condition to mark a chart, as an alert, a custom study, or as a rule in a trading system and as a condition for CQG’s Market Scan.