Bollinger Bands
Introduction to Bollinger Bands
Bollinger Bands are a powerful technical analysis tool that we use to measure market volatility and identify potential overbought or oversold conditions in the market.
Developed by John Bollinger in the 1980s, this tool consists of three lines—the middle line is a simple moving average (SMA), typically over 20 periods, while the upper and lower lines are the SMA plus or minus standard deviation.
The standard deviation aspect allows us to understand the price volatility and how far prices may stretch from the mean. When markets become more volatile, the bands widen; during less volatile periods, the bands contract.
Here’s a basic structure of Bollinger Bands:
| Component | Description |
|---|---|
| Middle Band | 20-period Simple Moving Average (SMA) |
| Upper Band | SMA + (20-period standard deviation of price × 2) |
| Lower Band | SMA – (20-period standard deviation of price × 2) |
We use these bands to spot possible price reversals and trend strength. For example, when a price touches the upper band, it may indicate the asset is overbought, while touching the lower band might show it’s oversold.
Keep in mind, the bands are not signals for automatic buys and sells on their own. We should employ them as a component of a broader analysis framework, integrating price action, volume, and other indicators to make more informed trading decisions.