I have a signed copy of John’s book “Bollinger on Bollinger Bands” — one of my all time favorite finance books. I told him his signature looked like abstract art, which it does. He laughed. Here’s his 15 Basic Rules, an insert from his book:
1. Bollinger Bands provide a relative definition of high and low.
2. That relative definition can be used to compare price action and indicator action to arrive at rigorous buy and sell decisions.
3. Appropriate indicators can be derived from momentum, volume, sentiment, open interest, intermarket data, etc.
4. Volatility and trend already have been deployed ni the construction of Bollinger Bands, so their use for confirmation of price action is not recommended.
5. The indicators used for confirmation should not be directly related to one another. Two indicators from the same category do not increase confirmation. Avoid collinearity.
6. Bollinger Bands can be used to clarify pure price patterns such as M-type tops and W-type bottoms, momentum shifts, etc.
7. Price can, and does, walk up the upper Bollinger Band and down the lower Bollinger Band.
8. Closes outside the Bollinger Bands can be continuation signals, not reversal signals as is demonstrated by the use of Bollinger Bands in some very successful volatility-breakout systems.
9. The default parameter of 20 periods for calculating the moving average and standard deviation and the default parameter of 2 standard deviations for the BandWidth are just that, defaults. The actual parameters needed for any given market or task may be different.
10. The average deployed should not be the best one for crossover signals. Rather, it should be descriptive of the intermediate-term trend.
11. If the average is lengthened, the number of standard deviations needs to be increased simultaneously-from 2 at 20 periods to 2.1 at 50 periods. Likewise, if the average is shortened, the number of standard deviations should be reduced-from 2 at 20 periods to 1.9 at 10 periods.
12. Bollinger Bands are based upon a simple moving average. This is because a simple moving average is used in the standard deviation calculation and we wish to be logically consistent.
13. Be careful about making statistical assumptions based on the use of the standard deviation calculation in the construction of the bands. The sample size in most deployments of Bollinger Bands is too small for statistical significance, and the distributions involved are rarely normal.
14. Indicators can be normalized with %b, eliminating fixed thresholds in the process.
15. Finally, tags of the bands are just that-tags, not signals. A tag of the upper Bollinger Band is not in and of itself a sell signal. A tag of the lower Bollinger Band is not in and of itself a buy signal.
I have a signed copy of John’s book “Bollinger on Bollinger Bands” — one of my all time favorite finance books. I told him his signature looked like abstract art, which it does. He laughed. Here’s his 15 Basic Rules, an insert from his book:
15 BASIC RULES
1. Bollinger Bands provide a relative definition of high and low.
2. That relative definition can be used to compare price action and indicator action to arrive at rigorous buy and sell decisions.
3. Appropriate indicators can be derived from momentum, volume, sentiment, open interest, intermarket data, etc.
4. Volatility and trend already have been deployed ni the construction of Bollinger Bands, so their use for confirmation of price action is not recommended.
5. The indicators used for confirmation should not be directly related to one another. Two indicators from the same category do not increase confirmation. Avoid collinearity.
6. Bollinger Bands can be used to clarify pure price patterns such as M-type tops and W-type bottoms, momentum shifts, etc.
7. Price can, and does, walk up the upper Bollinger Band and down the lower Bollinger Band.
8. Closes outside the Bollinger Bands can be continuation signals, not reversal signals as is demonstrated by the use of Bollinger Bands in some very successful volatility-breakout systems.
9. The default parameter of 20 periods for calculating the moving average and standard deviation and the default parameter of 2 standard deviations for the BandWidth are just that, defaults. The actual parameters needed for any given market or task may be different.
10. The average deployed should not be the best one for crossover signals. Rather, it should be descriptive of the intermediate-term trend.
11. If the average is lengthened, the number of standard deviations needs to be increased simultaneously-from 2 at 20 periods to 2.1 at 50 periods. Likewise, if the average is shortened, the number of standard deviations should be reduced-from 2 at 20 periods to 1.9 at 10 periods.
12. Bollinger Bands are based upon a simple moving average. This is because a simple moving average is used in the standard deviation calculation and we wish to be logically consistent.
13. Be careful about making statistical assumptions based on the use of the standard deviation calculation in the construction of the bands. The sample size in most deployments of Bollinger Bands is too small for statistical significance, and the distributions involved are rarely normal.
14. Indicators can be normalized with %b, eliminating fixed thresholds in the process.
15. Finally, tags of the bands are just that-tags, not signals. A tag of the upper Bollinger Band is not in and of itself a sell signal. A tag of the lower Bollinger Band is not in and of itself a buy signal.
Well Done Edward! Here is a slightly different angle which complements your excellent article.
https://buymeacoffee.com/wsdetectivx/coaching-corner-how-trade-using-bollinger-bands
Thanks Joe, great take!