Bollinger Bands

Created by John Bollinger, Bollinger Bands are similar to moving average envelopes. 

Study Type: Overlay

Description

The difference between Bollinger Bands and envelopes is envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting, widening during volatile markets and contracting during calmer periods.

As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper and lower band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices.

Traders generally use Bollinger Bands to determine overbought and oversold zones, to confirm divergences between prices and studies, and to project price targets. The wider the bands, the greater the volatility. The narrower the bands, the lesser the volatility.

Some authors recommend using Bollinger Bands in conjunction with another study, such as the RSI. If price touches the upper band and the study does not confirm the upward move (i.e. there is divergence), a sell signal is generated. If the study confirms the upward move, no sell signal is generated, and in fact, a buy signal may be indicated. If price touches the lower band and the study does not confirm the downward move, a buy signal is generated. If the study confirms the downward move, no buy signal is generated, and in fact, a sell signal may be indicated.

Another strategy uses the Bollinger Bands alone. In this approach, a chart top occurring above the upper band followed by a top below the upper band generates a sell signal. Likewise, a chart bottom occurring below the lower band followed by a bottom above the lower band generates a buy signal.

Bollinger Bands also help determine overbought and oversold markets. When prices move closer to the upper band, the market is becoming overbought, and as the prices move closer to the lower band, the market is becoming oversold. The market's price momentum should also be taken into account. When a market enters an overbought or oversold area, it may become even more so before it reverses. You should always look for evidence of price weakening or strengthening before anticipating a market reversal.

Bollinger Bands can be applied to any type of chart, although this study works best with daily and weekly charts. When applied to a weekly chart, the Bands carry more significance for long-term market changes.

Parameters

• Period: (20) - the number of bars, or period, used to calculate the study. John Bollinger, the creator of this study, states that those periods of less than ten days do not seem to work well for Bollinger Bands. He says that the optimal period for most applications is 20 or 21 days.
• Std Deviation Multiplier: (2) - or Band Width (the half-width of the band in terms of multiples of standard deviation).