Bollinger Bands

TA_Wen said...

BB(N, K) consists of a) a middle band being an N-period simple moving average, b) an upper band at K times an N-period standard deviation above the middle band, and c) a lower band at K times an N-period standard deviation below the middle band. Usually we choose BB(20, 2).

We expected that the price is oscillating between upper BB and lower BB. In another words, after the price LEAVES upper BB, we expect its next stop will be on lower BB, and vice versa.

An fast movement on the downside will expand BB range since the N-period standard deviation (sigma) increases. After that, if the price continues dropping with its momentum decreasing, sigma decreases so BB band (upper-lower) tightens. The follow-up of 50ema typically lags but it will catch up. If BB tightens faster than 50ema, the 50ema will fall below lower BB. This is purely a result of parameter selection for the indicators. BUT:

1. As the price stays below 50ema, the declining 50ema acts as a natural resistance;
2. As the price touches upper BB, it can stay there for a short while but it has the tendency to leave upper BB and go reaching lower BB.

Adding 1 and 2: it will be hard for the price to penetrate 50ema while sticking to to upper BB. So the upside profit could be rather limited even with positive divergence.

A chart for today's spy may help explaining it better:

http://stockcharts.com/h-sc/ui?s=SPY&p=5&yr=0&mn=0&dy=2&id=p79800031269&listNum=1&a=166538664

For 50ema below lower BB, back test some "gap-up" days and you will see. On those days you will find negative divergence but they couldn't play out.