Envelopes are formed with upper border U and lower border L.
The formula is:
U = ( 1 + u / 100 ) x SMA (P, n)
L = ( 1 – d / 100 ) x SMA (P, n)
U – upper border;
L – lower border;
u – % above the moving average;
d – % below the moving average;
SMA (P, n) – moving average.
The percentage (“u” and “d”) should be set so that about 95% of price activity is contained within the envelope and 5% outside it. The indicator will then be adequate to the market balance and all prices will come back to the envelope after they exit it.
Bollinger Band is constructed by placing upper and lower bands around a moving average – the band width is not constant but instead proportional to the mean square divergence from the moving average over the specified period of time. Based on the Bollinger Band analysis, the decision to enter/exit the market is made when the price rises above upper BB resistance or falls below lower Bollinger Band support.
If the price moves within upper and lower bands, then Bollinger Band analysis is not a reliable method to determine the best time to open/close positions. Once the price penetrates the band to, then come back to the previous levels, then it is considered a good time to open a position.
Sometimes, when the price penetrates the Bollinger Band and only “tries” new levels, but then comes back right away it may be a false breakout. If it is a true breakout then you have the possibility to trade against the trend. However, it is important to make sure that the breakout is false. In this case refer to the volume because it sharply decreases if the breakout is not false.
Bollinger Bands contract when the market is quiet, without sharp price movements, consolidating to continue the prevailing trend or produce a new one.
Bollinger Bands widen when the prevailing trend becomes stronger or at the beginning of a new trend. A good trend confirmation is when bands widen and volume rises.
In a bullish market, moving average is the support level, whereas in a bearish market it is the resistance level.
In order to add the indicator on the chart in MetaTrader 4 follow the «Insert -> Indicators -> Trend -> Bollinger Bands Menu