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The next major innovation came from Marc Chaikin of Bomar Securities, who, in attempting to find some way to have the market set the band widths rather than the intuitive or random-choice approach used before, suggested that the bands be constructed to contain a fixed percentage of the data over the past year. He stuck with the 21-day average and suggested that the bands ought to contain 85% of the data. Bomar bands were the result. Figure 3 depicts this powerful and still very useful approach. The width of the bands is different for the upper and lower bands. In a sustained bull move, the upper band width will expand and the lower band width will contract. The opposite holds true in a bear market. Not only does the total band width change across time, the displacement around the average changes as well.

BOLLINGER'S BRAINSTORM

Asking the market what is happening is always a better approach than telling the market what to do. In the late 1970s, while trading warrants and options and in the early 1980s, when index option trading started, I focused on volatility as the key variable. To volatility, then, I turned again to create my own approach to trading bands. I tested any number of volatility measures before selecting standard deviation as the method by which to set band width. I became especially interested in standard deviation because of its sensitivity to extreme deviations. As a result, Bollinger Bands are extremely quick to react to large moves in the market.

Bollinger Bands are plotted two standard deviations above and below a simple moving average. The data used to calculate the standard deviation are the same data as those used for the simple moving average. In essence, you are using moving standard deviations to plot bands around a moving average. The time frame for the calculations is such that it is descriptive of the intermediate term trend. (See Figure 4 for a precise mathematical definition and the formula.)

Figure 5 again depicts the DJIA, this time with Bollinger Bands. Note the bands' responsiveness to changing market conditions. The width of the bands varies by more than three times from point A to point B; note that many reversals occur near the bands and that the average provides support and resistance in many cases.

FIGURE 2: The concept emerged in the 1970s of shifting a moving average up and down by a certain number of points or a fixed percentage to obtain an envelope around price. Here, an envelope has been constructed around the Dow Jones Industrial Average (DJIA). The average used is a 21-day simple moving average. The bands are shifted up and down by 4%.

FIGURE 3: Marc Chaikin, to find some way to have the market set the band widths rather than the intuitive approach used before, suggested that the bands be constructed to contain a fixed percentage of the data over the past year. He stuck with the 21-day average and suggested that the bands ought to contain 85% of the data. Bomar bands were the result.