Definition:

Bollinger Bands are plotted a certain number of standard deviations away from a central moving average, which means they incorporate a measure of market volatility. This contrasts with Envelopes, which are drawn a fixed percentage difference away from an average.

The main advantage of Bollinger Bands involves the fact that they adjust to volatility conditions, which vary with the level of price swings seen over time. As a result, Bollinger Bands generally widen when the market experiences highly volatile periods and narrow during calmer trading periods.

Bollinger Bands will typically be plotted over the price action itself, although some traders prefer to put them underneath the price chart as an indicator. All-in-all, they have become one of the more popular technical indicators since they offer a variety of useful information that traders can use to profit from.

Sample Chart:

Usage:

Traders generally use Bollinger Bands as trading guides that theoretically should contain most market price swings between the upper line and the lower line of the indicator. This spread widens in more volatile markets, where large price swings become more likely, and narrows in calmer markets. Also, when a price movement initiates from one side of the band, it usually extends to reach the opposite side. This can be used to set price objectives when trading.

A simple trading strategy using Bollinger Bands might involve selling when the market is above the upper line and buying when it is below. That idea can be further refined to only signal trades in the direction of the trend. In this case, you would use Bollinger Bands to signal a short when the central average is sloping downwards and the market is trading above its upper band. Conversely, a long might be signaled when the central average slopes upward and the market is trading below its lower band.

In addition, Bollinger Bands provide several other useful trading signals. For example, when the band has contracted substantially due to low price volatility, this may be an indication that the market may subsequently break out and move sharply in either direction. Furthermore, if the price exceeds the upper line, this tends to indicate the current trend should continue. Alternatively, peaks and dips outside the band followed by peaks and dips inside the band, might indicate a trend reversal.

Calculation Method:

In general, Bollinger Bands are characterized by two outer lines, drawn in an equidistant fashion around a middle line that usually takes the form of some type of moving average. The most common Bollinger Band parameters involve using a 20-period Simple Moving Average for the middle line, with the top and bottom lines placed two standard deviations away.

Define:

• n= the number of time periods.
• Close(n)= The closing price of time period n.
• SMA(A,B)= A Simple Moving Average of data item A over B periods.
• SD(n)= Standard Deviation as of time period n.
• ML(n)= Middle Line as of time period n.
• TL(n)= Top Line as of time period n.
• BL(n)= Bottom Line as of time period n.
• D= Number of Standard Deviations that TL and BL lie away from ML.
• SQRT(A)= Square Root of A
• SUM(1,n,A) = Sum of A(i) from i=1 to i=n

Calculate:

• Standard Deviation or SD(n)= SQRT{SUM[1,n,Close(i)-SMA(Close(i))^2]/n}
• Middle Line or ML(n) = SMA(Close, n) = SUM[1,n,Close(i)]/n
• Top Line or TL(n) = ML(n) + D*SD(n)
• Bottom Line or BL(n) = ML(n) - D*SD(n)

Practice Bollinger Bands Trading

Technical analysis with Bollinger Bands is a demanding skill that requires practice to master. We recommend that you use a demo account to train yourself for free before applying your skills to real money trading.
Most reputale trading platforms today (for example: GFC Trader, AVA Trader, Meta Trader) feature technical indicator functions which can be applied on real-time charts. You can open a free account, download the trading software and start sharpening your technical analysis skills today!

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