Technical Indicators: %B

%B is an indicator derived from the Bollinger Bands created by John Bollinger. This indicator represents the difference between the most recent closing price in relation to the Bollinger bands. Readings of 1.0 represent the close is exactly at the upper band, and readings of 0.0 are exactly at the lower band. However this indicator is not bound by absolute levels and in theory is infinite, a reading of 1.1 highlights the most recent close is above the upper band by 10% of the width of the bands and a reading of -0.1 represent the close is below the lower band by 10% of the width of the bands.

As a reminder, typically two standard deviations should contain 95% of all data that is normally distributed. As equity returns are not normally distributed being skewed to the upside, this actually contains around 87% of all price data so moves outside the bands represent significant strength or weakness. The default setting for %B is based off the settings of Bollinger Bands (discussed here) with each band set 2 standard deviations above and below a 20-period simple moving average.

Similar to the Moving Average Convergence Divergence (MACD) indicator (discussed here) this indicator is unbound however it tends to have a range between -0.25 and 1.25. Therefore this indicator can be used to identify both over & under bought signals as well as identifying strong trends and divergences that signal potential reversals.

The calculation is as follows:

%B = (Close – Lower Band)/(Upper Band – Lower Band)

As mentioned above typically most readings will fall within -0.25 to 1.25 representing that the price is below the lower band by 25% of the band width and above the upper band by 25% of the band width. Using these readings we can generate over or under bought signals as potential buying and selling opportunities similar to that of the Relative Strength Index (discussed here).

Generally readings at or above 1 are viewed as over bought representing selling opportunities and those at or below 0 as under bought representing buying opportunities. The first chart below shows the price of WPL in the top pane with the Bollinger bands along with the %B indicator in the bottom pane.

The red arrows highlight where the %B indicator has crossed above the 1.0 level and we can see these signals generally coincide with a peak in the price which is followed by a pullback. The green arrows represent over sold signals that we can see coincide with the price pushing below the lower Bollinger band, which often mark an intermediate low and are followed by a bounce higher.

Next we can use the %B indicator to identify strong trends, the second chart below highlights SYD which trended strongly higher from October 2014 through to May 2015. On the 4th of November 2014 the price closed above the upper Bollinger band coinciding with a reading on the %B of 1.01. This means that the price closed 1% above the upper Bollinger band and is seen as a sign of strength.

As the first chart above of WPL showed that often readings above 1.0 were followed by a pullback so is the case with SYD and we can see multiple pullbacks during this time coinciding with readings above 1.0. What is important is that the %B indicator does not cross below the 0 line until May 2015 which signals significant weakness and a sign the trend may be ending. In strong uptrends it is very rare for the %B indicator to reach the 0 level.   

Finally similar to our other oscillator indicators the %B is very useful to identify divergences that signal trend strength is fading and the price is at an increased risk of a reversal. As a reminder a bullish momentum divergence is where the price moves to a new low however the %B forms a higher low while bearish momentum divergence is where the price moves to a new high only for the %B to form a lower high. The failure to move to a new high or low along with price signals that the momentum of the gain is not as significant as previous levels.

The third and final chart again shows SYD however this time highlighting the formation of clear bullish momentum divergence. In December the price closed at $5.99 coinciding with a reading of -0.09% representing the close is below the lower band by 9% of the band width. In January 2015 the price closed lower than December at $5.86 however the %B indicators forms a higher low at -0.02%. This forms clear bullish momentum divergence suggesting declines are becoming exhausted and we see this is then followed almost immediately by a sudden rally over the following fortnight.  

In summary the %B indicator is a very useful and dynamic tool to help identify over or under bought signals, trend strength and divergence signalling potential reversals. Confusion can arise when a reading above 1.0 which signals the price is over bought also representing significant strength and potential the start of a larger trend. Then it is important to understanding whether the price is within a trading range or breakout out of trading range into a trend so we can use the %B indicator appropriately. For further information on identifying trading ranges and trends click here. As always this indicator should be used with further analysis to confirm signals. 

This article was written by James Woods – Global Investment Analyst, Rivkin Securities Pty Ltd. Enquiries can be made via [email protected] or by phoning +612 8302 3600.