The Bollinger Bands indicator is widely used in technical analysis that measure market volatility and identify potential overbought or oversold zone in a stock, commodity, or other traded index. It was developed by John Bollinger in the 1980s.
Bollinger Bands indicator consists of three components:
- Middle Band (SMA): This is a simple moving average SMA of the price or index, It is usually calculated over 20 periods. It shows the trend direction.
- Upper Band: This one is plotted at a distance of about two standard deviations above the middle band(SMA). It depicts the price’s volatility, with the distance expanding or contracting based on how volatile the market is.
- Lower Band: Similarly, this band is plotted two standard deviations below the middle band(SMA), mirroring the upper band’s behavior.
Key Uses of Bollinger Bands:
- Volatility Indicator: When the bands widen, it means increased market volatility. When they shrink, it means lower volatility.
- Overbought/Oversold Conditions: When price hover near the upper band may suggest an overbought zone, while prices near the lower band may indicate an oversold zone. However, this should be confirmed with other indicators to avoid false signals.
- Trend Reversals: If the price consistently touches or exceeds the bands, it may signal a potential trend reversal and it may start moving in other direction.
Top 2 Strategies Using Bollinger Bands:
- Squeeze Strategy: When the bands contract tightly, it mostly signals that a period of low volatility is about to end, with a reasonable breakout in either direction.
- Breakout Trading: A sharp move outside the bands could suggest a strong breakout, but one should often wait for confirmation before taking action.
One should also consider some other indicators to support a downtrend or uptrend; some of the widely used such indicators are listed below.
1 Golder cross OR Death cross
2 Moving Average Convergence Divergence (MACD)
3 On-Balance Volume (OBV)
4 Stochastic Oscillator
Feel free to share your thoughts on Bollinger Bands or ask any questions in the comments below. Your feedback helps us improve, and we’re here to clarify any points you may have!