Bollinger Band %B

Introduction:

%B is an indicator derived from Bollinger Bands. In his book, Bollinger on Bollinger Bands, John Bollinger refers to %B as one of two indicators that can be derived from Bollinger Bands. The other indicator is Bollinger Band width.

%B quantifies a security's price relative to the upper and lower Bollinger Band. There are six basic relationship levels:

•%B equals 1 when price is at the upper band
•%B equals 0 when price is at the lower band
•%B is above 1 when price is above the upper band
•%B is below 0 when price is below the lower band
•%B is above .50 when price is above the 20-day moving average
•%B is below .50 when price is below the 20-day moving average

Calculation:
%B = (Price - Lower Band)/(Upper Band - Lower Band)

The default setting for %B is based on the default setting for Bollinger Bands (20,2). The bands are set 2 standard deviations above and below the 20-day simple moving average. Security price is the close or the last trade.

Signals: Overbought/Oversold

%B can be used to identify overbought and oversold situations. However, it is important to know when to look for overbought readings and when to look for oversold readings. As with most momentum oscillators, it is best to look for short-term oversold situations when the medium-term trend is up and short-term overbought situations when the medium-term trend is down. In other words, look for opportunities in the direction of the bigger trend, such as a pullback within a bigger uptrend. Define the bigger trend before looking for overbought or oversold readings.

Chart below shows within a strong uptrend. Notice how %B moved above 1 several times, but did not even come close to 0. Even though %B moved above 1 numerous times, these "overbought" readings did not produce good sell signals. Pullbacks were shallow as stock reversed well above the lower band and resumed its uptrend. John Bollinger refers to "walking the band" during strong trends. In a strong uptrend, prices can walk up the upper band and rarely touch the lower band. Conversely, prices can walk down the lower band and rarely touch the upper band in a strong downtrend.

After identifying a bigger up trend, %B can be considered oversold when it moves to zero or below. Remember, %B moves to zero when price hits the lower band and below zero when price moves below the lower band. This represents a move that is 2 standard deviations below the 20-day moving average. Below chart shows within an uptrend that began in March 2009. %B moved below zero three times during this uptrend. The oversold readings in early July and late October provided good entry points to partake in the bigger uptrend.


Signals: Trend Identification

John Bollinger's book also featured a trend-following system using %B with the Money Force Index, also known as the Money Flow Index (MFI). An uptrend begins when %B is above .80 and MFI is above 80. MFI is bound between zero and a hundred. A move above 80 places MFI in the upper 20% of its range, which is a strong reading. Bollinger suggested setting MFI periods at 1/2 the number of Bollinger Band periods, which would be 10. Downtrends are identified when %B is below .20 and MFI is below 20.

Chart below shows with Bollinger Bands (20,2), %B and MFI (10). An uptrend started in late July when %B was above .80 and MFI was above 80. This uptrend was subsequently affirmed with two more signals in early September and mid November. While these signals were good for trend identification, traders would likely have had issues with the risk-reward ratio after such big moves. It takes a substantial price surge to push %B above .80 and MFI above 80 at the same time. Traders might consider using this method to identify the trend and then look for appropriate overbought or oversold levels for better entry points.

Conclusions

%B quantifies the relationship between price and Bollinger Bands. Readings above .80 indicate that price is near the upper band. Readings below .20 indicate that price is near the lower band. Surges towards upper band show strength, but can sometimes be interpreted as overbought. Plunges to the lower band show weakness, but can sometimes be interpreted as oversold. A lot depends on the underlying trend and other indicators. While %B can have some value on its own, it is best when used in conjunction with other indicators or price analysis.

Bollinger Band %B

Parabolic SAR

Introduction

Developed by Welles Wilder, creator of RSI and DMI, the Parabolic SAR sets trailing price stops for long or short positions. Also referred to as the stop-and-reversal indicator (SAR stands for "stop and reversal"), Parabolic SAR is more popular for setting stops than for establishing direction or trend. Wilder recommended establishing the trend first, and then trading with Parabolic SAR in the direction of the trend. If the trend is up, buy when the indicator moves below the price. If the trend is down, sell when the indicator moves above the price.

Calculation

The formula is quite complex and beyond the scope of this definition, but interpretation is relatively straightforward. The dotted lines below the price establish the trailing stop for a long position and the lines above establish the trailing stop for a short position. At the beginning of the move, the Parabolic SAR will provide a greater cushion between the price and the trailing stop. As the move gets underway, the distance between the price and the indicator will shrink, thus making for a tighter stop-loss as the price moves in a favorable direction.


There are two variables: the step and the maximum step. The higher the step is set, the more sensitive the indicator will be to price changes. If the step is set too high, the indicator will fluctuate above and below the price too often, making interpretation difficult. The maximum step controls the adjustment of the SAR as the price moves. The lower the maximum step is set, the further the trailing stop will be from the price. Wilder recommends setting the step at .02 and the maximum step at .20.

The chart above shows how the Parabolic SAR can catch most trends and allow the trader to profit from the buy/sell signals. The default settings that Wilder recommends diminishes distracting fluctuations, but does not make the indicator immune to whipsaws (black arrow). A proper interpretation of this indicator would suggest that a trader should close long positions when the price falls below the SAR (red arrow) and close short positions when the price rises above the SAR (green arrow).

The Parabolic SAR works best during strong trending periods, which Wilder himself estimates occur roughly 30% of the time. Therefore, the user may first want to determine if the market is trending by using other indicators such as Wilder's ADX line.

PARABOLIC SAR