Bollinger Bands – A Primer.

OVERVIEW: A trading band is an ‘envelope’ around a certain indicator, generally a moving average. It consists of 2 lines one above and one below the indicator line. Each of these lines is equidistant and parallel to the indicator line. The distance between the indicator and the lines depends on the particular trading strategy. Trading bands are generally used to determine whether the prices are ‘strong’ or ‘weak’.

Bollinger bands is a type of trading band developed by John Bollinger. Bollinger determines the width of the band as a function of the market volatility. The width is normally one or two standard deviations above and below the moving average line.

CALCULATION: Each of the Bollinger band is placed at a distance equal to one or 2 standard deviations from the moving average. For every point in the moving average series, a new point is calculated for the upper as well as the lower band series.

INTERPRETATION: The width of the band and the period of analysis are two variables that will decide the accuracy of the analysis.

The width of the band is calculated as a function of market volatility. It is usually a factor of the standard deviation from the moving average. One or two standard deviations from the moving average is commonly used for analysis.

The period of analysis refers to the number of time slices as well as the total time period over which the analysis is performed. A 20-period time line is the recommended time period for the analysis.

Bollinger bands are used to study the relative ‘high’ or ‘low’ of price with respect to the previous price points. Prices typically move ‘within’ the Bollinger Bands envelope. Whenever the price moves outside of the envelope either upwards, or downwards, it is a sign of market strength or weakness respectively.

Whenever the market volatility decreases the bands move closer together. This in turn increases the possibility of the price moving outside the band. This can be seen in the sharp moves after a relatively calm market. Once investors witness a move in the upward direction, the uptrend will continue since other investors tend to follow suit. This is supported by the fact that the volatility in the market has not caught up with the market activity and hence the Bollinger envelope has not expanded sufficiently to contain the up trend.

The figure below shows the Bollinger band enveloping a candlestick chart.

Bollinger Bands.

Moving Averages – A Primer.

INTRODUCTION: Moving average is one of the most common indicators used by technical analysts to predict the market movement. A moving average is a series of points each of which is an average of a set of price points. For each new price point added to the price series, a new ‘moving average’ point is calculated and added to the moving average series.

The following are different types of moving average indicators.

SIMPLE MOVING AVERAGES: A simple moving average (SMA) is calculated by adding a fixed number, say ‘n’, of price points and dividing by the same fixed number, ‘n’. Each new point in the moving average series is calculated using the last ‘n’ price points. The very first moving average point can be calculated only after the first ‘n’ price points are available.

For eg. a 5-day SMA is calculated as follows:

5-day SMA = SUM(Price(n))/5

where n takes the values 1 through 5 and represents the price for the particular day.

WEIGHTED MOVING AVERAGES: The weighted moving average (WMA) is similar to the SMA, but each price point is assigned a weight. The oldest price point is assigned a weight of 1. The weight for each subsequent price point is increased by 1.

The WMA is calculated by using:

Sum(Price(m) * weight(m))/Sum(weights)

where m is assigned values from 1 to n, n being the number of periods for which the WMA is calculated.

EXPONENTIAL MOVING AVERAGES: An exponential moving average (EMA) is a type of moving average where the the most recent price point is given a higher weight in the moving average calculation. Also, unlike SMA and WMA, the older price points are not dropped out of the moving average calculation.

Each new point in the exponential moving average series is calculated as follows.
(previous EMA value + (2/(n+1) * current price point) )
where n is the number of time periods under consideration.

The EMA is thus more sensitive to the most recent price change than the SMA. This sensitivity reduces with increases in the number of time periods.

The 12 and 26-day EMAs are most commonly used; for longer term analysis 50 or 200-day EMA is used.

The following is a long-term moving average chart.

Moving Averages (Price)

Candlesticks – Overview – 1 of 4.

BASIC CANDLESTICK LAYOUT: Stock prices vary throughout the day and are used in computations and charts as the building blocks of technical analysis. At the end of the day, the price data is recorded and stored as ‘historic’ data. The ‘High’, ‘Low’, ‘Open’ and ‘Close’ are the four different price points of interest to technical analysts.

The Candlestick chart, originally invented by the Japanese, provides a basic layout to represent the H-L-O-C data. Each ‘candlestick’ represents the price data (H-L-O-C) for a single time slice, typically 1 day.

As shown in the figure below, the ‘body’ of the candlestick represents the ‘High/Low’ values, while ‘shadows’ represent ‘Open/Close’. The ‘upper shadow’ represents ‘High’ and the ‘lower shadow’ represents ‘Close’. If the body is green, the lower end is the ‘Open’ and the upper end is the ‘Close’. If the body is red, the lower end is the ‘Close’ and the upper end is the ‘Open’.



Candlestick charts are powerful tools that can be used to visually interpret the price movement. The green candlestick indicates a ‘bullish’ investor sentiment while a red one indicates a ‘bearish’ investor sentiment.

The size of the body as well as the shadows and the pattern formed by multiple candlesticks are used as patterns to predict future price movements in the market.

The figure below shows a 3-month candlestick chart of ABB Ltd. from www.mumbaitrader.com.

ABB Ltd. 3-month candlestick from www.mumbaitrader.com.

Technical Analysis – Learn the language.

1. SUPPORT: Support is defined as the price level at which the price stops going down. It is the price point on a chart at which the downtrend reverses and the price stops going further down.

2. RESISTANCE: Resistance is defined as the price level at which the price stops going up. It is a price point on a chart at which the uptrend reverses and the price stops going further up.

3. TREND: Technical analysis is used to study the strength of a ‘trend’ or ‘directional surge’ in a particular indicator. The sooner the trend is detected the greater the success of the technical analyst.

4. CONGESTION: Congestion is said to happen whenever a stock trades below support or above resistance or both. In this particular scenario, called congestion, there is an excess number of traders looking to exit their contract positions, in comparison to those willing to enter into a new offsetting position. This will force contract holders to sell at a discount, thereby keeping the stock price between the support and the resistance levels.

5. CORRECTION: Correction is defined as a temporary downtrend in the price movement of a stock. The temporary nature of a correction will result in it being ultimately followed by an uptrend . Technical analysts predict corrections so that they can enter into long positions and then benefit from the uptrend that is to follow.

6. BREAKOUT: A breakout is said to happen when the share price moves by a significant percentage outside of the current trading band. A breakout typically happens when the price increases by a significant amount above the current level of resistance.

7. CONTINUATION PATTERNS: A continuation pattern is said to occur whenever there is a temporary break in a certain trend after the price movement reverts back to the original trend.

8. REVERSAL PATTERNS: A reversal pattern is said to occur when after a breakout from a certain trend, the price movement is such that there is a turnaround in the trend.

9. MOMENTUM: Momentum is a technical indicator that measures the abolute difference between today’s closing price and the close from N days ago.

10. DIVERGENCE: A divergence is said to occur whenever the price and an indicator move in opposite directions.

Technical Analysis – does history repeat?

INTRODUCTION: Technical analysts are folks who will swear by the old adage ‘history does repeat itself’. Technical analysis strategies are based on the assumption that investors react the same way to the same types of events. Technical traders thereby use past data and patterns to predict future market movement.

CHARTS: Charts are the basis of technical analysis. Charts are used to study movement in the price and volume data of a stock over a period of time.

PRICE: Price refers to the actual price of the stock for each of the transactions that have occured during the given time period. This is the primary measure used in the different technical analysis studies.

VOLUME: Volume is the number of shares of the stock that have been traded during the given time period. It is a very important measure that is normally studied in connection with price.

For example, say, the price of a during the course of a day increases by 10%. If the volume during the same period also increases, then it is considered a strong trend, versus if the volume during the day had decreased.

TIME: Time refers to the period over which the price and volume data are studied. The ‘time’ can range from a few seconds to a few years. Most commonly used time periods are: intraday, daily, weekly, monthly, quarterly and annually.

Charts are generally used to study indicators, trends and patterns. All of these studies use the price and volume data over a certain time period to predict future market movement.

• A trend refers to the general direction in which the market is headed – ‘up’ or ‘down’ or ‘horizontal’. There are different trends that are studied by technical analysts.
• An indicator is an analysis performed to predict market direction. Indicator values are calculated using price and volume data. Some common indicators are moving average, MACD, RSI and so on.
• A pattern refers to a certain formation in the appearance of a chart. There exists some common patterns that indicate a certain trend in the price movement. Examples of common chart patterns are: Head & Shoulders, Cup & Handle, Double Tops & Bottoms, Triangles, Gaps, Wedge, Rounding Bottom and so on.

There is strong evidence both in favor of as well as against the effectiveness of technical analysis in accurately predicting market movement. However, this is a widely practiced method amongst the analyst community.

The following is an example of a technical chart of WIPRO over a 3-month period as seen in www.mumbaitrader.com.

Wipro technical chart from mumbaitrader.com