How to Calculate and Interpret Bollinger Band Width

Most stocks can experience periods of volatility, and determining the amount of that volatility can be an essential indicator of the relative risk of trading that particular asset. Many investors rely on the Bollinger Band Width (BBW) to assess the volatility of a stock and forecast changes in pricing trends. Read on to learn how to use this calculation as part of your trading strategy.

What Is the Bollinger Band Width?

Bollinger Bands, named for their creator, John Bollinger, are used in pairs in conjuction with a moving average. They show whether a stock price is trending higher or lower , and the distance between these bands is known as the Bollinger Band Width (BBW).

Statistically, the difference between the upper and lower Bollinger bands represents the standard deviation between the price and the simple moving average (SMA), and the BBW can provide a quick snapshot of the level of volatility in a particular stock. 

For example, a high BBW indicates a high level of volatility, while a narrow one shows that prices remain relatively close to the moving average.

How Does the Indicator Work?

As the BBW illustrates market volatility, it’s thought that it can also be used to help anticipate changes in volatility. That belief assumes that volatility will fluctuate between periods of expansion and contraction and that the width of the Bollinger Bands will serve as indicators of each period.

The BBW indicates the possibility of an upcoming increase in volatility through a trading signal known as “The Squeeze,” which happens when:

• The Bollinger bands are narrow, indicating relatively low volatility.
• Volatility suddenly increases, causing the price to break through one of the bands.

When the price surges through the upper band, it indicates a price increase, and if it drops through the lower band, it indicates a decline. As such, it’s theorized that a narrow BBW may precipitate a sharp change in volatility, with prices that could soon break out through either the upper (bullish trend) or lower band (bearish trend).

How to Calculate Bollinger Band Width

The Bollinger Band Width can be determined with the following simple calculation:

BBW = (Upper Band – Lower Band) / (Middle Band)

Here, the Middle Band represents the simple moving average, which allows you to calculate the BBW relative to the average price.

How to Read Bollinger Band Width Signals

Reading Bollinger Band Width signals is relatively straightforward. The narrower the band, the less volatility the stock is experiencing over the given timeframe. As outlined above, a bullish trend may occur if the stock price should break through the upper Bollinger Band, and conversely, should the price suddenly drop through the lower Bollinger Band, it may point to a bearish trend.

Possible 3 Bollinger Bandwidth Trading Strategies

Traders may use the data provided by the BBW to supplement their trading strategy in several ways.

1. Bollinger Bandwidth and the Broad Market

John Bollinger claims that if the Bollinger Band Width drops below 2%, it will lead to major changes in the S&P 500 market index. 

2. Double Bottom Trade Signals

Double bottom refers to the fact that the market index’s intraday prices are low, as well as a low Bollinger Band Width, which can both be indicators that the index may be oversold. If you anticipate a rebound, you might purchase stocks at a relatively discounted rate, hoping to profit if the index rebounds.

3. Major Trend Reversals

A major trend reversal may happen when volatility surges, which might represent a good time to establish a position. On the other hand, if the stock is experiencing volatility in the counter trend, it may be prudent to further evaluate the indicators before considering taking action.

Possible Advantages of the Bollinger Band Width

The BBW offers investors several possible advantages, such as:

• Measuring volatility
• Forecasting shifts in volatility trends
• Evaluating average price shifts over time

The BBW is a helpful tool that can be combined with other technical indicators and tools, such as oscillators and moving average crossovers to help gauge volatility level changes and associated price movement.

Things to Consider with the Bollinger Band Width

Investors should be aware of the limits of using the BBW, which include the following:

• Trend reversals don’t always correspond to periods of tight volatility.
• The BBW can’t predict the length of volatile periods.
• Moving averages can’t account for cyclical or seasonal price patterns.
• Indicators of increasing volatility don't necessarily predict direction of movement. (failed breakouts)

These considerations make for all the more reason to consider using the Bollinger Band Width in conjunction with other analytical methods.

Compare the Best Stock Brokers

For more tips on analysis, it may help to rely on a solid investing platform. The right tools can potentially make traders more effective and better inform their decisions. Here are some of the best stock brokers out there:

Better Decisions Can Be Made With Solid Data

Stock volatility can be challenging to forecast, but the Bollinger Band Width offers a less complex, visualized way to measure current volatility and estimate future shifts. Investors should consider using the BBW alongside other tools to help determine potentially advantageous entry and exit points and refine their trading strategy based on the most relevant and accurate available data.

Frequently Asked Questions