The bandwidth indicator is used to identify situations where an instrument in a trading range or consolidation pattern is about to begin a directional move. Bollinger Bands form an envelope drawn a number of standard deviations above and below a moving average.

Bandwidth measures the percentage difference between the upper and lower bands and therefore the volatility level.

However, different intervals may require different average and deviation calculations. The theory behind the bands is that the width of an envelope should be determined by the data-series itself rather than by the assumptions of the speculator, as done with percent envelopes. The bandwidth indicator allows for quick and objective visualization of expanding and contracting volatility periods over time.

It also allows for comparisons across time for an instrument with a large change in price as well as to other instruments since the result is normalized for price level.

Bollinger Bands Strategy - How To Trade The Bollinger Squeeze

See the Bollinger Bands document in the resource center for more on the bands. The first step is to determine what constitutes narrow and wide bands for a particular instrument. Bandwidth must be judged in comparison to recent history as well as in context to a longer period of time.

Therefore, there is not one level of bandwidth that is considered to be narrow or wide for all instruments and all times. This is similar to determining what it overbought or oversold with non-indexed momentum indicators such as MACD. John Bollinger postulated that volatility cycles from high to low and therefore Bollinger Bands also tend to expand and contract. Often times, traders can get advance warning to a breakout from a flat period of trading when the bands start to expand.

However, the direction of the breakout is not determined by band expansion alone. For that, traders must wait for prices to move above or below the bands to indicate the breakout in that direction.

The chart of Starbucks shows several examples of narrow bands followed by breakouts and continued moves in the direction of the break. While it would have been possible to trade the breakouts on the price chart, the added dimension of the bandwidth indicator made the three highlighted higher confidence calls.

There was no signal from the bandwidth indicator and that could have been enough to keep the trading from taking the trade and enduring what appears to be a quick reversal. Can you see another instance where the bandwidth indicator would have helped?

Bollinger Band®

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