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Better Bollinger bands
Futures, Oct 1998 by McNicholl, Dennis
Good news for short-term traders: By altering the trading band equations, your Bollinger bands will no longer desert you when a trend is brewing.
The original purpose of John Bollinger's trading bands was to form an envelope around a stock or futures price time series to act as a volatility gauge on the underlying market's price excursions. However, during a trend the original Bollinger bands often fail to track price closely enough to use them for any meaningful analysis.
Two reasons for the tracking problem are that the Bollinger center band shifts away from the center of the price series, and the two outer Bollinger bands, which form the envelope, shift outward to such an extent that the envelope loses its utility as a volatility gauge. This also happens when the market makes an explosive move in either direction.
"For starters" (below) shows a sample of a simulated time series that is stationary in the mean, but has a slowly increasing variance. The original Bollinger bands' performance here can be described as:
The center band (green line) remains properly positioned virtually on top of the time series mean or expected value (black line). Therefore, with stationary price movement, the original center band is an effective unbiased estimator of the mean of the price series.
The outer bands form an effective envelope around the price series. Each outer band is maintained a distance of two sample standard deviations from the center band. Because there aren't any large outliers in this example, the original bands adjust well to a slowly changing standard deviation.
But because the population standard deviation of the price series (blue line) around the mean (black line) in this case actually is $3, less than our $8.28, the original Bollinger outer bands are useless as a volatility envelope in this case.
Where (alpha) = the smoothing constant, 0
In "A better fit" (page 39), the center band displacement (AB) is corrected; the center band estimator is tracking the mean of the price series more closely, and the outer bands now function properly during the entire upward trend.
However, the correction of the displacement of the center band will not take care of all shortcomings inherent in the original Bollinger band methodology. "Still loose" (page 39) shows that a large price move or trend can cause the original Bollinger outer bands to bulge for the entire width of the moving sample window. This also will render the bands useless for a considerable amount of time.
"Tighten it up" (above) shows this quite dramatic change, which is similar to the change from "When trending" to "A better fit" for the center band. The Bollinger band volatility gauge around the price series now continues to function correctly both during periods of strong trends and periods of large price movements. FM
Dennis McNicholl is a trader and technical analyst. He can be reached via
mcnicholl@mindspring.com.
Copyright Oster Communications, Inc. Oct 1998
Provided by ProQuest Information and Learning Company. All rights Reserved
Bibliography for "Better Bollinger bands"
View more issues: Aug 1998, Sep 1998, Nov 1998
McNicholl, Dennis "Better Bollinger bands". Futures. Oct 1998. FindArticles.com. 17 Jul. 2008.
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