Bollinger %b
What is the Bollinger %b?
The Bollinger %b, like the Bollinger BandWidth (BBW) was developed by John Bollinger and is derived from the Bollinger Bands indicator. Unlike the Bollinger BandWidth (BBW), however, the Bollinger %b is a trend indicator that indicates the relationship between a security's price and the upper and lower Bollinger Bands. It can be used to identify overbought or oversold conditions within a trend, as well as the strength of the trend.
How is the Bollinger %b calculated?
The Bollinger %b is calculated in three steps:
- First, the difference between the upper and lower bands of the Bollinger Band is calculated by subtracting the value of the lower band from the value of the upper band:
Upper Band − Lower Band - Second, the difference between the Close price and lower band of the Bollinger Band is calculated by subtracting the price from the value of the lower band:
Closing Price − Lower Band - Finally, the difference between the Close price and lower band calculated in Step 2 is divided by the difference between the upper and lower bands calculated in Step 1. The result is an unbound indicator plotted as a line that can oscillate between values below zero and values above one.
The complete formula for the Bollinger %b is as follows:
%b = ( Closing Price − Lower Band ) ÷ ( Upper Band − Lower Band )
How is the Bollinger %b used?
Bollinger %b can be used to identify overbought and oversold conditions, and to gauge the strength of the trend. Identify overbought and oversold conditions is the primary use of the Bollinger %b.
- When the Bollinger %b is above 1.0, the price is above the upper band of the Bollinger Bands. This implies an overbought condition, which traders will try to exploit by waiting for a sell signal to short the market and a protective stop loss just below the middle band.
- Conversely, when the Bollinger %b is below 0.0, the price is below the lower band of the Bollinger Bands. This implies an oversold condition. Here traders will wait for a buy signal to go long the market with a protective stop loss just above the middle band.
However, these signals are more accurate when the market is in corrective phase. In other words, the price movement is against the larger trend. Thus, identifying short-term oversold conditions when the larger trend is an uptrend and short-term overbought conditions when the larger trend is a down trend, would be more appropriate. This would also allow the trader to trade in the direction of the larger trend.
Trend strength can be determined when the market is already in a trend.
- In an uptrend, the trend is strong when the Bollinger %b crosses above the 0.8 line. The trend weakens with the Bollinger %b crosses below the 0.8 line and moves towards the 0.5 line.
- In a downtrend, the trend is strong when the Bollinger %b crosses below the 0.2 line. The trend weakens with the Bollinger %b crosses above the 0.2 line and moves towards the 0.5 line.