What Are Bollinger Bands?
Bollinger Bands are volatility indicators that create a dynamic envelope around price. Learn how they work, what they indicate, and their limitations.
Bollinger Bands are a volatility indicator developed by John Bollinger in the 1980s. They consist of a middle band (typically a 20-period simple moving average) and two outer bands set at standard deviations above and below the middle band. The bands expand and contract based on market volatility.
How Bollinger Bands Work
The middle band is usually a 20-period SMA. The upper band is 2 standard deviations above the middle band; the lower band is 2 standard deviations below. When volatility increases, the bands widen. When volatility decreases, the bands narrow (called a "squeeze").
What Bollinger Bands Indicate
Bollinger Bands provide several types of signals.
Band Walk
In a strong trend, price can "walk" along the upper or lower band for extended periods. This is actually a sign of trend strength, not necessarily an overbought/oversold signal.
Squeeze
When bands narrow significantly, it suggests low volatility and often precedes a period of increased volatility. However, the squeeze does not predict direction.
Mean Reversion
Price tends to return to the middle band over time. However, this does not mean it will bounce at the exact band boundaries.
Bollinger Bands Limitations
Bollinger Bands reflect past volatility and do not predict future price direction. Price can remain at the bands for extended periods during strong trends. They work best when combined with other indicators and used within a broader analytical framework.
Key Takeaways
- •Bollinger Bands consist of a moving average with upper and lower volatility bands.
- •Bands widen during high volatility and narrow during low volatility.
- •They show relative price levels and volatility, not direction.
- •Bollinger Bands work best as part of a multi-indicator analysis.
Frequently Asked Questions
When do Bollinger Bands predict a breakout?
Bollinger Band squeezes (narrowing bands) often precede breakouts, but they do not predict the direction. The squeeze signals that volatility has been low and a larger move may be coming.
Important Limitations
Bollinger Bands are based on historical standard deviation and cannot predict future price movements. They are most effective in range-bound markets and can produce misleading signals during strong trends. StockVantex uses Bollinger Bands as one component of its technical analysis.