What Is a Bollinger Band in Technical Analysis?

According to the Investopedia, Bollinger Bands are a type of chart indicator for technical analysis and have become widely used by traders in many markets, including stocks, futures, and currencies. Created by John Bollinger in the 1980s, the bands offer unique insights into price and volatility.

Before we get to how they can do that, lets talk about what they are and what they look like. A Bollinger Band consists of a middle band (which is a moving average) and an upper and lower band. These upper and lower bands are set above and below the moving average by a certain number of standard deviations of price, thus incorporating volatility.

The general principle is that by comparing a stock‘s position relative to the bands, a trader may be able to determine if a stock’s price is relatively low or relatively high. Further, the width of the band can be an indicator of its volatility (narrower bands indicate less volatility while wider ones indicate higher volatility).

Using Bollinger Bands

The purpose of using Bollinger Bands is to measure the volatility of the market.

Basically, the Bollinger Bands tool tells us whether the market is CLAM or LOUD. When the market is CLAM, the Bollinger Bands contract, and when the market is LOUD, the Bollinger Bands expand.

As the chart below shows, when prices are CLAM, the upper and lower Bollinger Bands contract together, and when prices move higher, the Bollinger Bands begin to expand.

In fact, it is not necessary for you to know the algorithm of Bollinger Bands, the history related to Bollinger Bands and other irrelevant things. What is more important is to use the Bollinger Bands tool to guide your trading.

Typically, Bollinger Bands use a 20-period moving average, where the “period” could be 5 minutes, an hour or a day. By default, the upper and lower bands are set two standard deviations above and below the moving average. However, traders can customize the number of periods in the moving average as well as the number of deviations.

Figure: Bollinger Band activity over the course of 20 days.

Bollinger Band Bounce

One thing you need to know about Bollinger Bands is that price tends to return to the middle of the Bollinger band. This is the essence of a Bollinger Bands bounce. On the chart below, can you tell us in what direction price will move？

If your answer is down, then you are correct. As you can see on the chart, price is retracing towards the middle of the Bollinger band.

What you see here is just a classic Bollinger band bounce. The reason Bollinger band bounces are possible is that Bollinger bands play the role of dynamic support and resistance.

The longer the price is inside the Bollinger band, the more obvious the role of support or resistance the Bollinger band plays. Some traders have set up the following trading system - a system that primarily uses Bollinger band bounces to take profits and is one of the best strategies to use when the market is range-bound and has no obvious direction of movement.

Now, let's see how to use the Bollinger Bands tool when the market is in a trend.

Bollinger Band Squeeze

Bollinger band squeezing is self-explanatory. When Bollinger bands are squeezed together, it usually means that a breakout is about to start.

If the candlestick starts to break above the upper Bollinger band, then the price will usually continue to move higher. If the candle line breaks down through the lower Bollinger band, then the price usually continues to move lower.

As you can see in the chart above, the Bollinger bands are squeezed together. Price has only just started to break above the upper Bollinger band. Based on this information, where do you think price is going to move？

If you said up, then you are correct. This is a classic Bollinger Band squeeze.

This strategy is designed to help traders catch price movements early. However, this phenomenon does not happen every day, but if you look at the 15-minute chart, you are likely to encounter this phenomenon several times in a week.

Conclusion

There are many other ways to trade Bollinger bands, but the two mentioned above are the most common ones. As we all know, book reading is not enough, and a better understanding requires practice in person. Thus, investors still need to learn more about the properties of the trend in the real world, and slowly digest it and integrate it into their own analysis system. I hope the above teaching will be beneficial to you.

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