Ch8. Bollinger Bands and Volatility Indicators

Bollinger Bands

Developed by John Bollinger in the 1980s. A dynamic band built around a moving average using standard deviation.

Components:
Middle Band: 20-period Simple Moving Average (SMA)
Upper Band: Middle Band + (2 × Standard Deviation)
Lower Band: Middle Band - (2 × Standard Deviation)

Statistical meaning:
→ Approximately 95% of price action falls within the bands
→ Band width = current measure of volatility

Interpreting Bollinger Bands

Bandwidth

Squeeze:
→ Narrowing band width = volatility contraction = explosive move brewing
→ Direction unknown → wait for breakout direction before entering

Expansion:
→ Surge in volatility = strong trend confirmed
→ Price riding along the upper band = strong uptrend in progress

Price and Band Relationship

Band Walk:
→ In a strong trend, price travels along the band
→ Upper Band Walk = strong uptrend (NOT a sell signal!)

Reversal Signals:
→ W Bottom: price touches lower band → bounces → approaches lower band again but fails to touch → Buy
→ M Top: price touches upper band → falls → approaches upper band again but fails to touch → Sell

ATR (Average True Range)

Developed by J. Welles Wilder. Measures volatility in absolute terms:

TR (True Range) = MAX of:
1. Current High - Current Low
2. |Current High - Previous Close|
3. |Current Low - Previous Close|

ATR = 14-period exponential moving average of TR

ATR-Based Stop-Loss Placement

ATR Stop-Loss:
Long entry: Entry Price - (2 × ATR) = Stop Price
Short entry: Entry Price + (2 × ATR) = Stop Price

Example:
Apple (AAPL) entry at $180, ATR = $3.50
Stop-loss = $180 - (2 × $3.50) = $173

Advantages:
→ Logical stop sized to current volatility (more precise than a fixed % stop)
→ Wide stop when volatility is high / tight stop when volatility is low

ATR-Based Position Sizing

Risk Amount = 1–2% of account
Position Size = Risk Amount ÷ (2 × ATR)

Example:
Account: $50,000 | Risk 1% = $500
ATR = $3.50
Position Size = $500 ÷ (2 × $3.50) = ~71 shares

Bollinger Bands + Keltner Channel Squeeze

TTM Squeeze (John Carter strategy):

Keltner Channel:
Middle Line: 20-period EMA
Upper: 20-period EMA + (1.5 × ATR)
Lower: 20-period EMA - (1.5 × ATR)

Squeeze Condition:
Bollinger Bands inside Keltner Channel → Squeeze active
= Extreme volatility contraction = explosive move imminent

Direction Filter:
Confirm momentum direction when squeeze fires → enter trade

Bollinger Band Squeeze = volatility contraction = explosion pending (direction unknown) Band Walk ≠ overbought/oversold — strong trends ride along the band ATR Stop-Loss: Entry ± 2×ATR (volatility-adjusted, logically sized) Position Size = Account Risk Amount ÷ (2×ATR)