Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our term of the day is “Bollinger Bands” Bollinger Bands are volatility bands placed
above and below a moving average.
Volatility is based on the standard deviation, which changes as volatility increases and
decreases.
The bands automatically widen when volatility increases and narrow when volatility decreases.
This dynamic nature of Bollinger Bands also means they can be used on different securities
with the standard settings.
For signals, Bollinger Bands can be used to identify M-Tops and W-Bottoms or to determine
the strength of the trend.
Standard deviations are a statistical unit of measure describing the dispersal pattern
of a data set.
By definition, one standard deviation includes about 68% of all data points from the average
in what is referred to as a normal distribution pattern, while two standard deviations include
about 95% of all data points.
When working with Bollinger Bands, it is not necessary for you to calculate standard deviations
yourself.
You need only understand the theory of how standard deviation sets the range for a dispersal
of rates when compared to the moving average, and how this information is used to determine
buy and sell channels in the chart.
The area between the moving average line and each band produces a range, or channel.
The area above the moving average is referred to as the buy channel as prices displayed
in this region remain higher than the moving average and suggest upward momentum.
Conversely, prices falling below the moving average are in the sell channel as the spot
rate is declining more rapidly than the moving average which suggests that the exchange rate
has downward momentum.