Bollinger bands are a technical analysis (TA) tool developed in 1980 by John Bollinger, a financial analyst. Bollinger bands are defined as volatility bands in technical analysis and are placed above or below moving averages. Volatility varies according to the standard deviation. Rises or falls in volatility affect the standard deviation.
The purpose of Bollinger bands is to visually display price volatility and potential overbought or oversold conditions. In other words, Bollinger bands aim to predict how often and how extremely the price of an asset moves. When the price approaches the upper band, it is considered relatively high, while when it approaches the lower band, it is considered relatively low. Traders often use Bollinger bands to identify trend reversals, overbought and oversold zones, and volatility changes.
Almost all price fluctuations occur within the Bollinger band channel but do not give trading signals if it breaks out of the channel.
What Do Bollinger Bands Do?
Bollinger bands are two lines drawn over the average of an asset's price over a while. These lines are based on the standard deviation of its price and are usually one or two percent. These lines indicate possible price movements and are used to predict these movements.
Using Bollinger bands is useful for predicting the highs and lows in the price movements of a financial asset and evaluating a transaction accordingly. One of the most important advantages of Bollinger bands is that they help to measure market volatility. Bollinger bands can also help identify trends and are used to predict when the price of a financial asset will fall and when it will rise.
How Do Bollinger Bands Calculate?
The first step in calculating Bollinger bands is to calculate the simple moving average of the asset, usually using a 20-day simple moving average (SMA). The 20-day SMA takes the average of the closing prices for the first 20 days as the first data point. Bollinger bands consist of three lines drawn on the price chart. The middle line is usually set as the simple moving average (SMA), while the upper and lower lines are calculated based on standard deviations from the middle line. The middle line, i.e. the Bollinger band, is usually set as the 20-day simple moving average.
Middle band: 20-day simple moving average
Upper band: 20-day simple moving average + (20-day standard deviation x2)
Lower band: 20-day simple moving average - (20-day standard deviation x2)
What Is Bollinger Band Squeeze?
The price movements of a financial asset can sometimes continue at a horizontal level for a while. In this case, the Bollinger bands will converge and appear stuck. A Bollinger band squeeze usually indicates that volatile price fluctuations are imminent. It is possible that sudden price fluctuation on the squeeze band could create a new trend.
Squeeze bands may indicate that there is an accumulating momentum in the market and a sharp swing in price is imminent. In this case, the price usually breaks out of the bands, and a new trend begins. At the same time, squeeze bands also indicate to traders that a potential opportunity or risk is approaching. However, a squeeze band does not give a clue in which direction the price will move. Therefore, other technical analysis tools should be taken into account to correctly interpret the price movement following a squeeze band.
What Is Bollinger Band Expansion?
A Bollinger band expansion occurs when the price fluctuations on it increase in the market. This expansion gives traders a clue that a new trend may be starting.
Bollinger band expansion usually signals increased volatility and strong shifts in price fluctuations. In this case, the price often breaks out of the bands and could be the start of a new trend. However, an expansion does not provide definitive information about the continuation or reversal of a trend.
How Is Bollinger Band Used in Technical Analysis?
The Bollinger band expands when volatility is high and squeezes when volatility is low. An expanded Bollinger Band indicates that the market is on the verge of a trend change. A squeeze Bollinger Band indicates that there is a high probability of a sharp price movement soon.
Investors know when the price of an asset is too high when it crosses the upper band and too low when it crosses the lower band. If the price touches the upper band several times, it indicates that the area is strong resistance. Similarly, if it bounces off the lower band several times, it is a strong support zone. Bollinger bands often provide information about the overall state of the market. Since the Bollinger band is a volatility-dependent indicator, it is considered more suitable for short-term analysis. Like other indicators, the Bollinger band alone cannot be sufficient for technical analysis.
