Learning Series: Bollinger Bands
What is a Bollinger Band?
Bollinger Bands are an indicator that measures price action as well as volatility of a tradable asset. The financial analyst John Bollinger originally developed the concept of two volatility bands surrounding a simple moving average based on standard deviation in the 1980s. Bollinger Bands use two parameters: Period and Standard Deviations. These values can be adjusted to the preference of the individual trader but are generally two standard deviations with a twenty day SMA (simple moving average).
Figure 1 — Bollinger Bands — Source: Fidelity.com
As you can see in Figure 1, volatility generally increases during a large widening of the bands. Tightening bands during periods of low volatility usually indicate a significant price movement in either direction. In certain situations, this price movement can be the beginning of a trend shift.
Figure 2 — Bollinger Band Structure — Source: commodity.com
Price action typically occurs in the range of the upper and lower bands. Therefore, Bollinger Bands are useful for picking price targets. For example, If price breaks through resistance at the SMA then the upper Bollinger band would provide a good level for profit taking. If the price breaches either of the bands, it signals a strong trend continuation. However, traders must be cautious of false breakouts. As with all indicators, Bollinger Bands are not meant to be used alone and work best in conjunction with other indicators to confirm a bias.
Thank you for reading this installment of the Dolomite Learning Series. Happy Trading!
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Disclaimer: The information here is intended to be used for educational purposes only and is not financial advice. I am not a financial adviser.
