Bollinger Bands®: What They Are, and What They Tell Investors

As the period is shortened or lengthened, the coverage changes, which affects the analysis efficiency. To maintain coverage at 88-89%, Bollinger Bands should be plotted using a 1.9 ratio for a 10-bar period. With a period of 50 bars, respectively, you need to increase the width from 2.0 to 2.1. To sum up, Bollinger Bands are a valuable technical analysis tool. Using the bands to indicate overbought/oversold conditions depends on the concept of mean reversion of the price.

Bollinger Bands are a technical analysis tool developed by John Bollinger in the 1980s for trading stocks. The bands comprise a volatility indicator that measures the relative high or low of a security’s price in relation to previous trades. Volatility is measured using standard deviation, which changes with increases or decreases in volatility. The bands widen when there is a price increase, and narrow when there is a price decrease. Due to their dynamic nature, Bollinger Bands can be applied to the trading of various securities. Mean reversion strategies can work well in range-bound markets, as prices can be seen noticeably bounce between the two bands.

Using Bollinger Bands

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In a downtrend, prices should not break above the upper band since this would indicate that the trend may be reversing, or it is slowing. If the price pulls back within the uptrends, and it stays above the middle band and moves back to the upper band, that indicates a lot of strength. Generally, a price in the uptrend should not touch the lower band, and if it does, it is a warning sign for a reverse or that the stock is losing strength. When the price breaks through the upper or lower band, the trader buys or sells the asset, respectively. The classic M top is formed by a push to a high, followed by sell-off reaction, and then a test of the previous high. Watching the price behave like this, a trader may wonder if the stock is in a new uptrend, or if it has met its resistance.

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Therefore, these formations are often used to predict trend reversals and open positions. Another feature of W-bottoms is the presence of some smaller formations in their structure. A closer look at smaller timeframes reveals reversal signals. They form the beginning or end of the compound segments of a large figure. The next move will be a second touch inside the lower Bollinger Band. It is important to pay attention here that the low in the considered strategy is determined by the lower https://www.bigshotrading.info/.

Bollinger Bands can be used in most time frames, from very short-term periods, to hourly, daily, weekly or monthly. Such techniques usually require the sample to be independent and identically distributed, which is not the case for a time series like security prices. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Bollinger Bands are a type of price envelope developed by John Bollinger. (Price envelopes define upper and lower price range levels.) Bollinger Bands are envelopes plotted at a standard deviation level above and below a simple moving average of the price. Because the distance of the bands is based on standard deviation, they adjust to volatility swings in the underlying price.

Volatility and the bands

As John Bollinger acknowledged, “tags of the bands are just that, tags, not signals.” A tag (or touch) of the upper Bollinger Band® is not in and of itself a sell signal. A tag of the lower Bollinger Band® is not in and of itself a buy signal. Flexible and visually intuitive to many traders, Bollinger Bands® can be a helpful technical analysis tool. Invented in 1983 by John Bollinger, they’re designed to help traders evaluate price action and a stock’s volatility. Because Bollinger Bands® are computed from a simple moving average, they weigh older price data the same as the most recent, meaning that new information may be diluted by outdated data. Also, the use of 20-day SMA and 2 standard deviations is a bit arbitrary and may not work for everyone in every situation.

bollinger bands are a trend indicator that detect the volatility and dynamics of the price on the market. During periods of low volatility, the bands are narrow, while Bollinger Bands expand drastically during periods of high volatility. The consensus is that when the price reaches the upper band, it is considered as overbought, and when the price approaches the lower band, it is deemed to be oversold. Bollinger Bands can also assist in predicting trend reversals. However, traders should remember that Bollinger Bands are based on historical information. Therefore, the bands can only react to price movements but not predict future price movements.

Scanning for Bollinger Bands

The bands widen when there is a price increase and narrow when there is a price decrease. Due to their dynamic nature, Bollinger Bands may be applied to various trading instruments, such as stocks, commodities, futures, and Forex. In trading, market participants use two contrasting types of analysis.

If you actively trade, now is a good time to keep a close eye on as much information as you can—including what’s happening in the charts. Narrowing Bollinger Bands (i.e., when the bands move closer together) could suggest that volatility is decreasing—as investor sentiment potentially becomes more optimistic or complacent. As the chart above shows, this is not the case for the S&P 500 as the bands have actually widened a bit since mid-December 2022. Recently, the S&P 500 has been in the upper part of the band, which suggests US stocks are overvalued on a short-term basis (see Bollinger Bands applied to the S&P 500® Index chart). In the trading process, we will need to determine the levels 0.95 and 0.05. The third indicator will be the Bollinger Bands %b, which is already familiar to us from the previous strategy.

Snap Back to the Middle of the Bands

At the top of the terminal, open the “Insert” tab, then go to the “Indicators” item. Next, click on the “Custom” item and select the name of the newly installed indicator – Bollinger_Bands_3b. First, let’s add Bollinger Bands and RSI to the EURUSD chart of  LiteFinance online terminal. To do this, click on the “Indicators” button at the top of the chart. Then, in the menu that opens, click on the “Bollinger Bands (BB)” and “RSI” links.