Smoothing
the Bollinger %b indicator

Bollinger Bands are from John Bollinger and are mentioned in his book “Bollinger on Bollinger Bands” (Bollinger, 2001).

The Bollinger Bands consist of a set of three curves drawn in relation to price data. The middle band usually is a simple 20-bars moving average, which serves as the base for the upper and lower bands.

Upper Band = Middle Band + 2 * 20-period closing prices standard deviation
Lower Band = Middle Band - 2 * 20-period closing prices standard deviation

 

%b is a measure of where price is in relation to the outer Bollinger bands and therefore strongly related to volatility. %b is created as an oscillator to show overbought and oversold situations when price is moving close or beyond the upper or lower Bollinger bands.

This is the basic %b formula:

%b = (close – lower band) / (Upper band – lower band)

In the figure below you can see the GAIAM Inc price chart at the top and the basic closing prices %b indicator at the bottom.

The final smoothed indicator you can see in step 4 (SVE_BB%b_HA) and is the result of a number of smoothing techniques.

Look for the whole article and formulas in the Stocks & Commodities magazine of May 2010.

In a follow-up article I will show some trading technique using this indicator.

 

 

 

 

Read the complete article that will appear in the S&C May issue...

Pete Rast from Avarin systems, Inc. back tested the SE_BB%b indicator with this result...

While Sylvain Vervoort will be introducing a trading system in his next article in STOCKS & COMMODITIES, in his article in this issue, "Smoothing The Bollinger %b," he provides us with some interesting ideas on how this indicator might be used. In fact, by following his suggestion of identifying a divergence with price, we were able to create an impressive custom trading system on our own. To evaluate our customized system, we evaluated the S&P 500 stocks from 2004 through 2009 using a spread of 0.04 and commissions of $10.00 on each side. The average annual return for this six-year period was nearly 10%, while a buy and hold of the S&P index itself was just 0.1 %. Percentage of profitable trades was nearly 75%, and the system was profit­able in five of the six years. Only in 2008 did it have a loss of 17.5%, far less than the S&P index itself. While these results are impressive on their own, they were also done with a static set of parameters and no additional trading rules. StrataSearch users can explore this system fur­ther by running an automated search for supporting trading rules. Improved parameter sets can also be explored through the automated search.

Pete Rast –Avarin systems, Inc. www.StrataSearch.com

 

Excerpt of the June issue...

Often, the SVE_BB%b is a leading indicator making smooth moves with clear turning points. Normal and hidden divergent moves make it an ideal tool to help find entry and exit points while watching price moving between the Bollinger bands. In my last article, I looked at how this indicator could help traders identify entry and exit points while prices are moving between the bands. This time, I will introduce a good trading system using the SVE_BB%b and include some ideas together with other technical analysis tools. There are some tricks that could help traders start:

1 Use a candlestick chart when applying the SVE_BB%b. This is because candlesticks tell you more. You will look for candlestick reversal patterns to get a confirmation of a possible turnaround.

2 Use the most basic tools like support, resistance, and trendlines. Knowing that the SVE_BB%b is a leading indicator, you will just use the turning points of the indicator above and below the active standard deviation reference levels as a signal to start drawing a trendline and not as a signal for a direct buy or sell.

3 Keep a close eye on convergent and divergent moves between price and indicator. Ideally, you would open or close a position after a standard positive or negative divergent move. The bottoms or tops of this divergence are preferably spaced closer together than the price move
before the divergence because price correction waves are generally moving faster than price trend waves. Look for hidden divergences and interpret them as a possible continuation of the previous up- or downtrend.

4 Use 20-, 50-, and 200-day simple moving averages. Use the 20-day simple moving average as an aid to draw trendlines with the short-term price move. Use the 50- and 200-day simple moving averages as dynamic support and resistance levels.

5 Use a fast-responding trailing stop to get in and out of a trade. A good example would be one like my TR&NDS trailing stop introduced in the July 2009 issue of STOCKS & COMMODITIES. Use this stop as a warning signal. Look closely at the evolution of price at that moment in time. This trailing stop is considered broken only if crossed by the high price.

6 Always take care of the risk-to-reward ratio before entering a trade.

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