Volatility Based Indicators

Bollinger Bands

This tool is a very popular measure of volatility. It is similar to the Moving Average Envelope in that it uses both an upper and lower band around a central moving average. The difference is that Bollinger Bands use the statistical measure of standard deviation to position the level of the upper and lower limits. The tool provides a lot of information for the trader including trend identification, profit and loss price targets and buy and sell signals. An example of the use of Bollinger Bands can be seen in the chart below for the FTSE 100 Index Future.

The Bollinger Bands (the two red lines) are two standard deviations away from the moving average centre line (blue line) indicating the region in which the market has closed in 95% of occasions within the specified time period. The Bollinger Bands compare the current closing price with the moving average closing price. This gives an indication of the current volatility relative to the average. When volatility is high and prices close far away from the moving average, the Bollinger bands increase to accommodate more possible closing prices that can fall within 95% of the mean. Conversely, when volatility is low the standard deviation will be lower and the Bollinger bands will begin to converge towards the moving average centre line. The most common time period used is 20.