What is Bollinger Bands?
Definition
Bollinger Bands are a technical analysis tool consisting of a middle band (20-period SMA) and two outer bands set at two standard deviations above and below the middle band. They dynamically adjust to volatility, widening during volatile periods and narrowing during calm periods.
Detailed Explanation
Developed by John Bollinger in the 1980s, Bollinger Bands use statistical properties to define relative high and low price levels. Approximately 95% of price action falls within two standard deviations, so prices touching the upper band are statistically high and prices touching the lower band are statistically low.
The Bollinger Squeeze is one of the most popular signals. When the bands narrow significantly (low volatility), it often precedes a large price move. This is because low volatility tends to cluster and eventually gives way to high volatility. Traders watch for the squeeze and then trade in the direction of the breakout, often confirmed by volume expansion.
Bollinger Band width (upper band minus lower band divided by middle band) quantifies volatility. Extremely low band width values indicate potential breakout setups. The %B indicator measures where price falls within the bands: 1.0 at the upper band, 0.5 at the middle, and 0.0 at the lower band.
A common misconception is that touching the upper band is bearish and touching the lower band is bullish. In strong trends, price can ride the upper or lower band for extended periods (called walking the band). Bollinger himself recommends using other indicators like RSI or volume to confirm whether a band touch represents a reversal or a continuation.
Formula
Upper Band = 20-SMA + (2 x 20-period Std Dev); Lower Band = 20-SMA - (2 x 20-period Std Dev)Example
If a stock's 20-day SMA is $100 with a standard deviation of $5, the upper band is $110 and lower band is $90. A price touching $110 is at a statistical extreme.
Frequently Asked Questions
What does a Bollinger Band squeeze indicate?
Should I buy when price touches the lower Bollinger Band?
Related Terms
Volatility
Volatility measures the degree of variation in a stock's price over time. Higher volatility means larger and more frequent price swings, indicating greater uncertainty and risk. It is commonly expressed as the annualized standard deviation of returns.
Moving Average
A moving average is a technical indicator that smooths price data by calculating the average price over a specific number of periods. It helps identify trends, support and resistance levels, and potential buy or sell signals by filtering out short-term price noise.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of recent price changes on a scale of 0 to 100. Readings above 70 typically indicate overbought conditions, while readings below 30 suggest oversold conditions.
Support and Resistance
Support and resistance are price levels where a stock historically tends to stop falling (support) or stop rising (resistance). These levels form because of concentrated buying or selling interest and are foundational concepts in technical analysis.
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Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.
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