If you've used the Bollinger Bands for any length of time, you are going to notice that breakout alerts will be more accurate when the bands are closer together.
Bollinger band width is an indicator made from Bollinger Bands. In his book, Bollinger on Bollinger Bands, John Bollinger identifies Bollinger band width as one of two indicators that may be made from Bollinger Bands. The second indicator is %B.
Non-normalized band width calculates the space, or difference, relating to the top band and also the lower band. Band width diminishes as Bollinger Bands narrow and grows as Bollinger Bands widen. As Bollinger Bands are based on the standard deviation, falling band width shows lessening volatility and increasing band width demonstrates growing volatility.
Bollinger band width is better with regard to determining volatility and what is generally known as The Squeeze. This happens any time volatility drops to a very low level, as evidenced with the narrowing bands. The upper as well as lower bands derive from the standard deviation, that is a measure of volatility. For this reason, volatility shrinks when the bands narrow. The bands narrow as price flattens or moves inside a rather narrow range. The theory is that times of reduced volatility are followed by time periods of high volatility.
The market cycles to and fro between reduced volatility (range contraction) and increased volatility (range expansion). Times associated with lower volatility are generally followed by time periods of greater volatility.
Reasonably narrow band width (i.e. the Squeeze) may predict a large move up and also decline. After the Squeeze, a price surge and following band break signal the beginning of a new move. A fresh advance will start with the Squeeze and subsequent break over the top band. A fresh decline begins with the Squeeze and also subsequent break under the lower band.
As a stock's price moves sideways, the Bollinger Bands come together because volatility goes down. At this point, you need to look for your entry. Should the price breaks the upper Bollinger Band, you've got a volatility breakout to the upside and that means you take a long position. In case the price breaks below the lower Bollinger Band, there is a volatility breakout on the downside which means you enter a short position.
The closer the Bollinger Bands get together, the more effective the signal is on the breakout over either the upper or lower Bollinger Band wall.
Applying Bollinger Bands as a volatility breakout indicator may also be used on weekly charts or longer timeframes. Volatility and band width on weekly charts is greater than on the daily chart. This is just common sense because greater price movements can be expected during longer timeframes.
The risk in employing Bollinger Bands as a volatility breakout indicator arises from what is also known as a head fake. Head fakes are when the top or bottom Bollinger Band is broke just to reverse a couple of days later and stop you out of your position.
Certain markets tend to be more susceptible to head fakes as compared to some others at various times of the year. Take a look at past Squeezes for the stock you are looking at trading and find out if they included head fakes in the past.