BOLLINGER BANDS - The methods as explained by John Bollinger in his book , Bollinger on Bollinger Bands
Trading bands, which are lines plotted in and around the price structure to form an envelope, are the action of prices near the
edges of the envelope that we are interested in. They are one of the most powerful concepts available to the technically based
investor, but they do not, as is commonly believed, give absolute buy and sell signals based on price touching the bands. What
they do is answer the perennial question of whether prices are high or low on a relative basis. Armed with this information, an
intelligent investor can make buy and sell decisions by using indicators to confirm price action.
But before we begin, we need a definition of what we are dealing with. Trading bands are lines plotted in and around the price
structure to form an "envelope." It is the action of prices near the edges of the envelope that we are particularly interested in.
The earliest reference to trading bands I have come across in technical literature is in The Profit Magic of Stock Transaction
Timing; author J.M. Hurst's approach involved the drawing of smoothed envelopes around price to aid in cycle identification.
Figure 1 shows an example of this technique: Note in particular the use of different envelopes for cycles of differing lengths.
The next major development in the idea of trading bands came in the mid to late 1970s, as the concept of shifting a moving
average up and down by a certain number of points or a fixed percentage to obtain an envelope around price gained popularity,
an approach that is still employed by many. A good example appears in Figure 2, where an envelope has been constructed
around the Dow Jones Industrial Average (DJIA). The average used is a 21-day simple moving average. The bands are shifted
up and down by 4%.
The procedure to create such a chart is straightforward. First, calculate and plot the desired average. Then calculate the upper
band by mult