Asking the market what is
happening is always a better approach than
telling the market what to do. In the late
1970s, while trading warrants and options and in
the early 1980s, when index option trading
started, I focused on volatility as the key
variable. To volatility, then, I turned again to
create my own approach to trading bands. I
tested any number of volatility measures before
selecting standard deviation as the method by
which to set band width. I became especially
interested in standard deviation because of its
sensitivity to extreme deviations. As a result,
Bollinger Bands are extremely quick to react to
large moves in the market.
In Figure 5, Bollinger
Bands are plotted two standard deviations above
and below a 20day simple moving average. The
data used to calculate the standard deviation
are the same data as those used for the simple
moving average. In essence, you are using moving
standard deviations to plot bands around a
moving average. The time frame for the
calculations is such that it is descriptive of
the intermediateterm trend.
Note that many reversals
occur near the bands and that the average
provides support and resistance in many cases.
There is great value in
considering different measures of price. The
typical price, (high + low + close)/3, is one
such measure that I have found to be useful. The
weighted close, (high + low + close + close)/4,
is another. To maintain clarity, I will confine
my discussion of trading bands to the use of
closing prices for the construction of bands. My
primary focus is on the intermediate term, but
short and longterm applications work just as
well. Focusing on the intermediate trend gives
one recourse to the short and longterm arenas
for reference, an invaluable concept
For the stock market and
individual stocks. a 20day period is optimal
for calculating Bollinger Bands. It is
descriptive of the intermediateterm trend and
has achieved wide acceptance. The shortterm
trend seems well served by the 10day
calculations and the longterm trend by 50day
calculations.
The average that is
selected should be descriptive of the chosen
time frame. This is almost always a different
average length than the one that proves most
useful for crossover buys and sells. The easiest
way to identify the proper average is to choose
one that provides support to the correction of
the first move up off a bottom. If the average
is penetrated by the correction, then the
average is too short. If, in turn, the
correction falls short of the average, then the
average is too long. An average that is
correctly chosen will provide support far more
often than it is broken. (See Figure 6.)
Bollinger Bands can be
applied to virtually any market or security. For
all markets and issues, I would use a 20day
calculation period as a starting point and only
stray from it when the circumstances compel me
to do so. As you lengthen the number of periods
involved, you need to increase the number of
standard deviations employed. At 50 periods, two
and a half standard deviations are a good
selection, while at 10 periods one and a half do
the job quite well.
50 periods with
2.5 standard deviation 
10 periods with
1.5 standard deviation 
Upper Band =
50day SMA + 2.5(s)
Middle Band = 50day SMA
Lower Band = 50day SMA  2.5(s) 
Upper Band =
10day SMA + 1.5(s)
Middle Band = 10day SMA
Lower Band = 10day SMA  1.5(s) 
In most cases, the nature
of the periods is immaterial; all seem to
respond to correctly specified Bollinger Bands.
I have used them on monthly and quarterly data,
and I know many traders apply them on an
intraday basis.
