Bollinger Bands Indicator

In the 1980s, John Bollinger invented the “Bollinger Bands.” It is the most popular technical analysis tool used by traders. As an investor or trader, it is important to understand technical analysis to understand past market data and to predict future market trends. Traders use Bollinger bands to identify potential price trends and reversals. Read on to learn more about Bollinger bands, Bollinger bands indicator, Bollinger bands strategy, Bollinger bands settings, How Bollinger bands work, Bollinger bands calculation, and more.

What is Bollinger Bands?

Bollinger Bands is a technical analysis tool that includes a moving average line and two standard deviation lines that are plotted above and below the moving average line. It is used to determine whether the prices of stocks, commodities, currencies, futures, or options are high or low over the period. The “bands” are represented as an envelope above and below a Simple Moving Average (SMA) of the price. The upper and lower bands are two standard deviations above and below the SMA. The moving average line is usually set at 20 days which can be adjusted according to the preference of the traders. With the help of Bollinger bands, traders can identify the volatility and potential price range of the stock.

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Types of Bollinger Bands Indicator

Below are the types of Bollinger band indicators to help you:

• Upward Middle band – It indicates an uptrend suggesting to buy or hold long positions
• Downward middle band – It indicates a downtrend suggesting to sell or hold short positions.
• Narrow Bands (Squeeze) – It indicates less volatility (potential for significant price move), suggesting to prepare for a breakout and consider entry points.
• Moving outside the upper band or Price touching – It indicates potentially overbought (poised to fall in price) suggesting selling, shorting, or tightening stop-loss orders.
• Falling outside the lower band or Price touching – It indicates potentially oversold (poised to go up) suggesting Buying or tightening stop-loss orders.
• Price bounces off the lower band – It indicates the upper band becomes a potential exit point if the trend reverses suggesting taking profits or setting up a trailing stop-loss.
• Price touches the upper band – it indicates the lower band becomes a potential target if the reversal occurs suggesting taking profits or setting a trailing stop-loss.
• Price bounces off the lower band – It indicates the upper band becomes a potential exit point if the trend reverses suggesting taking profits or setting up a trailing stop-loss.
• Price touches the upper band – it indicates the lower band becomes a potential target if the reversal occurs, suggesting taking profits or setting a trailing stop-loss.
• Price bounces off the lower band – it indicates the upper band becomes a potential exit point if the trend reverses suggesting taking profits or setting up a trailing stop-loss.
• Price touches the upper band – it indicates the lower band becomes a potential target if the reversal occurs, suggesting taking profits or setting a trailing stop-loss.
• Price rebounds from upper or lower bands towards the middle band – It indicates potential buying or selling opportunity, especially in ranging markets ("Bollinger Bounce"), suggesting entering long or selling a trailing stop-loss.
• Price move starting at the upper band and continuing outside it, with increased volume – It indicates a potential breakout considering entering long positions or setting stop-loss orders below recent lows.
• Decisive move below the lower band, with high volume – It indicates a breakdown or the start of a new bearish trend, suggesting entering short positions or setting stop-loss orders below recent lows.
• Widening bands after a squeeze – It indicates an imminent breakout suggesting to prepare for entry or watch for confirmation signals.
• Widening bands – It indicates an increase in volatility and the potential beginning of a strong price trend suggesting to adjust risk management.
• Tightening bands (squeeze) – It indicates a period of lower volatility and consolidation; often a precursor to a major price move or breakout suggesting a breakout; consider entry points; tighten stop-loss orders.
• Longer squeeze – it indicates a more potent breakout coming suggesting for a larger price move; increase position size.
• Tightening bands – it indicates there's no consensus in the market about the future price direction suggesting adjusting risk management or waiting for clearer signals before entering positions.

How do Bollinger bands work?

When you use the Bollinger Bands Indicator, there will be three lines showcasing different aspects. You can use the Bollinger bands indicator across any assets to analyze.

·    Middle Band: It represents a 20-day SMA of the prices.

·    Upper Band: It is plotted two standard deviations above the SMA line.

·    Lower Band: It is plotted two standard deviations below the SMA line.

Bollinger Bands Calculation

 Bollinger bands calculation is simple and can be performed in a few steps. Use the below

Bollinger bands formula:

• Step 1: Calculate a simple moving average.
• Step 2: Calculate the standard deviation over the same number of periods as the simple moving average.
• Step 3: For the upper band and lower band follow the below instructions:
  Add for standard deviation to the moving average for the upper band
  Subtract the standard deviation from the moving average for the lower band.

Bollinger Bands Formula

• Bollinger Middle Band = 20-day simple moving average (SMA)
• Upper Band = 20-day SMA + (20-day standard deviation of price x 2)
• Lower Bank = 20-day SMA – (20-day standard deviation of price x 2)

Values used:

• Short term: 10-day moving average, bands at 1.5 standard deviations. (1.5 times the standard dev. +/- the SMA)
• Medium term: 20-day moving average, bands at 2 standard deviations.
• Long-term: 50-day moving average, bands at 2.5 standard deviations.

Conclusion
Bollinger bands are generally used by various traders and investors for investing. However, you should not completely depend upon the Bollinger bands as they are not always accurate. Market conditions depend on several factors and can rapidly change and the bands may not always accurately reflect current volatility levels. Also, if you rely totally on the bands can lead to losses as false signals can occur.

It is advisable for making an informed decision traders should use Bollinger bands along with other technical indicators and fundamental analysis to identify signals. Alongside this, you must take into consideration the risk tolerance and trading style while using Bollinger bands or any other technical indicator.