Stocks & Commodities V. 24:13 (50-57): Bandwidth Volatility Extremes by Barbara Star, Ph.D.
Knowing when volatility has reached extremes could work in your favor.
Volatility refers to the range or spread between high and low prices over a given time, be it intraday, daily, or
weekly. When price consolidates or moves sideways, the price range is small and volatility is low. However, when the price range expands or prices rise and fall sharply over short periods of time, volatility is high.
Volatility shifts from low to high and high to low as price grows, slows, or changes direction. Knowing when volatility has reached extremes could be a profitable piece of trading information.
The popular Bollinger Bands offer a visual way to track the ebb and flow of volatility. The width between the upper and lower bands reflects the expansion and contraction of price movements in relation to a moving average. John Bollinger developed the BandWidth indicator as an adjunct to the Bollinger Bands specifically to track changes in bandwidth movement. He found that changes in bandwidth often result in price corrections or reversals.
By virtue of its relationship to a moving average, bandwidths are comparable between securities in that they rise when volatility expands and contract when volatility declines. However, a moving average is based on the underlying security’s price, so the numeric values of bandwidths are not necessarily comparable. For instance, a bandwidth value of (2) may represent acute contraction in one security but not another.