Ever since John Bollinger introduced his Bollinger Bands in the early 1980s they have been a favourite indicator to all technical trades. This article is about the probabilities of Bollinger bands.
How good are the chances to be outside or inside of the bands in the future? How do these probabilities relate to the current position of the market relative to the Bollinger bands? What impact has overall volatility on these statistics? These questions will be answered.
Bollinger Bands Breakout Probability
By definition of the indicator most of of the times the market will trade inside the Bollinger band. But what happens in the future? Where will the market be in some days from now. These are the questions which interest me from a truing point of view.
So I did some test on the forward prediction qualities of the Bollinger band indicator. For all tests I used the 20 day, 2 standard deviations setting, which is the standard setting for most charting packages. I then looked at the positioning of the market 20 days after relative to its current Bollinger band.
The first test was done on the S&P500 index, using data since 1983. The indicator shown on the screenshot below gives the probability of the market being outside today’s Bollinger band in 20 days from now.
The red line is the probability of being outside todays band if we are already out of the band today. The green line shows the probability of being outside of today’s band in 20 days from now if we are trading inside of the band today.
The outside starters being outside the band in the future more likely than the inside starters, is most probably due to the trend lines of the market. Once a break is done there is a high probability it either vigorously reverses or that it carries on. Both events lead to an outside of today’s Bollinger band event.
100%-outside probability is the probability to be inside todays band in 20 days from now. It is less than 50%, regardless of today’s market relative to the band.