Bollinger Bands
Quick Answer
A volatility indicator consisting of a middle band with two outer bands that expand and contract with price volatility.
What are Bollinger Bands?
Bollinger Bands are a versatile technical analysis tool created by John Bollinger in the 1980s. They provide a relative definition of high and low prices, helping traders identify potential overbought or oversold conditions and volatility patterns.
The indicator consists of three lines: a middle band and two outer bands. About 95% of price action typically occurs within the bands.
The Three Bands
Middle Band A 20-period simple moving average (SMA). This represents the intermediate-term trend.
Upper Band Middle band + (2 × standard deviation). This line expands when volatility increases.
Lower Band Middle band - (2 × standard deviation). This line also responds to volatility changes.
Trading Strategies
The Squeeze When bands contract tightly, it signals low volatility and often precedes a significant move. Traders watch for the breakout direction.
Band Walks In strong trends, price can 'walk' along the upper or lower band. This isn't necessarily a reversal signal.
Mean Reversion Price tends to return to the middle band. Touches of outer bands can signal potential reversals in ranging markets.
Real-World Example
Before major moves, Bollinger Bands often contract in what's called a 'squeeze.' This pattern preceded the breakout in GameStop stock in January 2021.