Indicators: Volatility Bands Percent

[Automated-Trading]

Volatility Bands Percent:

From May 2010 issue of Futures magazine: Fixing the Bollinger Bands by David Rooke.

Popularized by John Bollinger, who gave them their name, Bollinger Bands are simply a plot of a multiple of the standard deviation of price from its Simple Moving Average (SMA), both above and below. By the use of standard deviation, we should reasonably expect that the distribution of price around the mean should conform to statistical normality, or get close to it.

Unfortunately, this is not the case for Bollinger Bands and has led to a search to fix the problem. Based on observations of Bollinger Bands, here are some of the issues:

• They are saddled with high lag, as virtually all SMA-based indicators are. Consequently, the user should be mindful of the delay in what the Bands present.
• They do not envelope price in a manner consistent with a Gaussian distribution. That is, 68.2% of prices should be found within one standard deviation of the sample mean, 95.4% of prices should be found within two standard deviations of the mean, etc. This will be described as the price/band ratio. While it can be debated whether daily price changes are normally distributed, the Bollinger price/band ratio can be said to offer little or no information from a probabilistic perspective.
• The price/band ratio is not scale invariant. That is, the price/band ratio from a given standard deviation does not remain constant as timescales increase.

This is the version that David Rooke proposes as a solution to fix the mentioned issues but in a percent representation (instead of drawing it on a main chart it is a separate window indicator showing the percent position of the price in the volatility bands).

Author: Mladen Rakic