DEFINITION of Bollinger bands
Bollinger bands are a popular form of technical price indicator. They are a technical analysis indicator. And derived from the standard Bollinger Bands indicator.
WHAT IT IS IN ESSENCE
It is a set of lines which are show two standard deviations. The deviations can be positive and negative. It is away from a simple moving average of the security’s price. The pioneering technical trader, John Bollinger, developed them in the 1980s.
Bollinger bands comprise a market’s moving average. And do that with an upper and lower price channel either side of it. Each price channel (or band) represents the standard deviation away from the moving average of the market.
As a market becomes volatile, its Bollinger bands will expand (it is called expansion). As it flattens out they will contract (contraction). In this way, they enable traders to see beyond short-term volatility and gain insight into longer price movements.
They are a volatility indicator that creates a band of three lines. They are plotted in relation to a security’s price. The Middle Line is typically a 20 Day Simple Moving Average.
How does it work? They are volatility bands with location above and below a moving average.
Volatility is obvious in the standard deviation. As volatility increases and decreases, deviation changes. The bands automatically expand when volatility increases. And narrow when volatility decreases. This dynamic nature of Bollinger Bands also means that traders can use them on different securities with the standard settings.
As it is said, moves that touch or exceed the bands are not signals, but rather “tags”. On the face of it, a move to the upper band shows strength. While a sharp move to the lower band shows weakness. Momentum oscillators work much the same way.
HOW TO USE
The use of this form of technical price indicator can also indicate whether a market’s direction is into the overbought or oversold field. Say, a market’s price continually moves outside the upper parameters of a Bollinger band. It can be considered to be overbought.
And when it moves below the lower band it could be considered oversold.
While very useful to a lot of traders, but they are not infallible. They only work with a thorough understanding of how fundamental and technical analysis works with markets.