Quick definitionCopy link to section
A Bollinger Band is a technical indicator that measures market volatility
Key detailsCopy link to section
- A Bollinger Band is a technical analysis indicator used to measure market volatility.
- A Bollinger Band primarily consists of a set of lines plotted from a simple moving average that can be adjusted to fit any trading strategy.
- Bollinger Bands show levels of highs and lows when it comes to price action.
What is a Bollinger Band?Copy link to section
A Bollinger Band is a technical analysis indicator used to measure market volatility. Simply put, the indicator tells whether the market is in a period of low or high volatility, depending on the size of the bands and how prices oscillate.
A Bollinger Band primarily consists of a set of lines plotted from a simple moving average that can be adjusted to fit any trading strategy. The standard deviation aspect is the measure of volatility in the bands.
For instance, whenever the market is highly volatile, then the bands would widen and narrow whenever the market is less volatile. Bollinger Bands show levels of highs and lows when it comes to price action.
How do Bollinger Bands work?Copy link to section
Bollinger Bands are technical indicators that can be loaded onto any price chart. Bollinger Bands consist of three lines:
- Middle Band (Simple Moving Average, SMA): This is typically a 20-day moving average of the asset’s price.
- Upper Band: This is the middle band plus two times the standard deviation of the asset’s price over the same 20-day period. It represents the “upper limit” of the price range.
- Lower Band: This is the middle band minus two times the standard deviation of the asset’s price over the same 20-day period. It represents the “lower limit” of the price range.
The Bollinger bounceCopy link to section
The Bollinger Bounce is an aspect of Bollinger Bands whereby price tends to move to the middle of bands from time to time.
The bounce occurs because the Bollinger Bands act as levels of support and resistance from which traders enter and exit positions, triggering price movements. The highest level of a Bollinger Band is often seen as a statistically high or expensive level, which prompts traders to exit positions. Conversely, the lower band is often seen as a low or cheap level, consequently attracting buy orders.
The bounce that occurs at the bands has made Bollinger Bands ideal trading indicators for range-bound markets.
The Bollinger squeezeCopy link to section
In addition to being effective in range-bound markets, Bollinger Bands also find great use in trending markets. The Bollinger Squeeze refers to the narrowing of Bollinger bands, signalling a potential breakout on the horizon.
Whenever the bands constrict and come close to each other, it is always indicative of low volatility, signalling potential future build-up in volatility. The wider apart the bands are, the likelihood is that volatility decreases after some time on traders exiting positions after a spike.
After the narrowing of the Bollinger Bands, whenever candlesticks start to break out above the topmost band, then the price of the underlying asset will most of the time head higher. Conversely, whenever candlesticks start to break out below the bottom band, then the price will usually edge lower, indicating the formation of a downtrend.
Breakouts above or below Bollinger Bands occur from time to time, mostly as a result of a major event. While the breakouts are always indicative of strength in a given direction, they should never be relied upon as trading signals. A breakout could trigger oversold or overbought situations whereby the price could bounce back or collapse afterwards.
In addition, whenever new highs and lows are made outside the Bollinger Bands, followed by highs and lows inside the bands, that could signal a potential reversal of the prevailing trend.
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