A technical indicator derived from the Bollinger Bands that show the relative measure of the width of the Bollinger Bands.
Overview:
The Bollinger Bandwidth indicator looks at the width of the Bollinger bands, which represents the volatility. A move that is accompanied by increasing volatility has a better chance of continuing.
The Equation of the Bollinger Bandwidth is as follows:
Bandwidth = (Bollinger Upper Band – Bollinger Lower Band) / Bollinger Middle Band
Volatility is high when the Bollinger Bands are farther apart and low when the Bollinger Bands are closer together. Based on the assumption that price (and volatility) is cyclical – periods of low volatility inevitably followed by periods of high volatility and vice versa and so forth, traders can learn to look for volatility breakouts using this indicator.
The Bollinger Bandwidth in the EUR/GBP Weekly Chart during the 2007 Squeeze
Source: VT Trader
Interpretation:
Traders use the Bollinger Bandwidth to identify the “Squeeze”. The Squeeze is identified when the Bandwidth is at its lowest low value within n-periods and represents the “calm before the storm”
A breakout in volatility can be used to confirm breakouts in price action.
Traders should be on the lookout for “false breakouts”, where price breaks out in one direction immediately following the Squeeze , only to quickly reverse and push for a breakout in the opposite direction. You can call this type of action, “whipsaw” action.
