Volatility-based indicators have a lot to offer when it comes to understanding a specific instrument's momentum. The most well-known indicator in this class is likely the Bollinger Bands system, which is widely used around the world.
There are, however, several indicators directly derived from the bands system that provide a better visualization of certain market conditions.
One of these variations will be examined in this article: the Band Width, which provides critical information regarding the dynamic relationship between price action and volatility.
The Band Width Concept
Simply put, the Band Width measures the spread (difference) between the upper and lower Bollinger Bands, normalized relative to the moving average. Conceptually, we have:
Decreasing Band Width: Signals a decrease in volatility.
Increasing Band Width: Signals an increase in volatility.
Calculating Bollinger Band Width
First, the three lines of the Bollinger Bands are calculated:
Upper Band: Moving Average + (Standard Deviation x Multiplier)
Lower Band: Moving Average - (Standard Deviation x Multiplier)
Center Band: Moving Average of the closing price over the specified period
Following this, the Width is calculated:
Width: Upper Band - Lower Band (to find the distance between them) divided by the Center Band and multiplied by 100 to display the result as a percentage.
The indicator formula can be seen in the figure below. The moving average referenced is the baseline average used to calculate the standard deviations within the Bollinger Bands method.
Applying Bollinger Band Width
To insert the indicator, click on the View Menu, select Indicators, and search for Bollinger Band Width.
The primary application of the Band Width is based on the band-tightening technique. The core concept is that a squeeze meaning an above-normal decrease in volatility precedes a powerful move ahead.
Consequently, the Band Width gives the trader time to build a position before a volatility expansion occurs (the separating of the bands).
When the squeeze happens, the subsequent move tends to be strong and high-amplitude. In these situations, breakouts of key support or resistance levels are highly common, and they frequently occur without a pullback reaction (a return to the recently broken level).
The squeeze is identifiable on the Band Width when the indicator drops to a historically lower level than it typically displays.
Notes
The Band Width is an indicator that can add substantial value to a trader's daily routine.
However, it is strictly necessary to combine other analysis methods with this indicator, as it does not provide directional data. It signals a high probability of an impending sharp move but does not specify the direction.
To address this limitation, complementary techniques must be integrated. Analyzing RSI and OBV divergences, to name two examples, are widely utilized methods.
It is also worth noting that each asset has its own unique volatility signature; therefore, historical analysis provides invaluable data when applying the Band Width.
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