IFC Markets
Questrade - Empowering you to take control of your financial future. Join the journey!

What are Bollinger Bands?​

Bollinger Bands are a popular technical analysis tool used by traders to assess market volatility and identify potential buy and sell signals. Developed by John Bollinger in the 1980s, Bollinger Bands consist of three main components:

Components of Bollinger Bands

Middle Band (Simple Moving Average - SMA)
  • This is typically a 20-period simple moving average of the asset's price.
  • It serves as the baseline around which the other bands are plotted.

Upper Band
  • Calculated as the middle band plus a certain number of standard deviations (usually 2) of the price.
  • Formula: Upper Band = SMA + (Standard Deviation * n), where n is typically 2.

Lower Band
  • Calculated as the middle band minus the same number of standard deviations.
  • Formula: Lower Band = SMA - (Standard Deviation * n), where n is typically 2.

Interpretation and Use

  • Volatility Measurement: The bands widen when volatility increases and narrow when volatility decreases.
  • Trend Identification: Prices oscillating within the bands suggest a stable trend, while frequent touches of the upper and lower bands indicate a volatile market.
  • Buy and Sell Signals:
    • Overbought and Oversold Conditions: When the price touches the upper band, it may indicate that the asset is overbought. Conversely, when the price touches the lower band, it may indicate that the asset is oversold.
    • Price Reversals: Traders often look for price reversals at the upper or lower bands. For instance, if the price hits the upper band and then starts to move downward, it could signal a sell opportunity.
    • Breakouts: A strong move beyond the bands can indicate a continuation of the current trend. For example, if the price breaks above the upper band with high volume, it may signal a bullish continuation.

Example of Bollinger Bands Calculation

  1. Calculate the 20-period SMA (Middle Band).
  2. Calculate the standard deviation of the price over the same 20 periods.
  3. Calculate the upper and lower bands using the standard deviation and the SMA.

Visual Representation

On a chart, Bollinger Bands would look like three lines:
  • The middle band (SMA) running through the center.
  • The upper band above it.
  • The lower band below it.

Practical Considerations
  • Market Conditions: Bollinger Bands are more effective in ranging markets than in strongly trending markets.
  • Combining with Other Indicators: Traders often use Bollinger Bands in conjunction with other indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) to confirm signals.
  • Customization: The default setting of 20 periods and 2 standard deviations can be adjusted based on the trader's strategy and the specific asset being analyzed.

By understanding and utilizing Bollinger Bands, traders can gain insights into market volatility, identify potential entry and exit points, and enhance their overall trading strategy.
Forexmart
InstaForex