Bollinger Bands, a technical indicator developed by John Bollinger are used to measure a market’s volatility and identify “overbought” or “oversold” conditions.
Basically, this little tool tells trader whether the market is quiet or whether the market is LOUD!
When the market is quiet, the bands contract and when the market is LOUD, the bands expand.
Look at the chart below. The Bollinger Bands (BB) is a chart overlay indicator meaning it’s displayed over the price.
Notice how when the price is quiet, the bands are close together. When the price moves up, the bands spread apart.
The upper and lower bands measure volatility or the degree in the variation of prices over time.
Because Bollinger Bands measure volatility, the bands adjust automatically to changing market conditions.
What are Bollinger Bands?
Bollinger Bands are typically plotted as three lines:
- An upper band
- A middle line
- A lower band
The middle line of the indicator is a simple moving average (SMA).
Most charting programs default to a 20-period, which is fine for most traders, but trader can experiment with different moving average lengths after you get a little experience applying Bollinger Bands.
The upper and lower bands, by default, represent two standard deviations above and below the middle line (moving average).
The concept of standard deviation (SD) is just a measure of how spread out numbers are.
If the upper and lower bands are 1 standard deviation, this means that about 68% of price moves that have occurred recently are CONTAINED within these bands.
If the upper and lower bands are 2 standard deviations, this means that about 95% of price moves that have occurred recently are CONTAINED within these bands.
the higher the value of SD trader use for the bands, the more prices the bands “capture”.
The Bollinger Bounce
One thing trader should know about Bollinger Bands is that the price tends to return to the middle of the bands.
That is the whole idea behind the “Bollinger Bounce.”