What are Bollinger Bands?
Bollinger Bands, developed by John Bollinger in the 1980s, consist of three lines: a 20-period simple moving average (middle band), an upper band at 2 standard deviations above, and a lower band at 2 standard deviations below. The bands automatically widen during high-volatility periods and narrow during low-volatility periods, providing a dynamic framework for assessing whether prices are relatively high or low.
Trading Strategies with Bollinger Bands
The Bollinger Squeeze occurs when the bands narrow to their tightest point in several months and is watched as a possible precursor of a significant price move, though it does not indicate the direction. Some mean-reversion traders buy when price touches the lower band and sell at the middle band. In trending markets, prices can 'walk the band,' repeatedly touching or exceeding the upper band during uptrends.
Key Considerations
A touch of the upper or lower band is not automatically a sell or buy signal. Bollinger himself emphasizes that the bands provide relative definitions of high and low, not absolute trading signals. The default 20-period, 2-standard-deviation settings are only defaults, and Bollinger notes that the parameters needed for a given market or task may differ.