Bollinger Bands are a volatility indicator that creates dynamic channels around price. They adapt to market conditions, expanding in volatile markets and contracting in quiet markets.
What Are Bollinger Bands?
Definition
Bollinger Bands:
- Three-line indicator
- Based on standard deviation
- Adapts to volatility
- Created by John Bollinger
Components
Three Bands:
- Upper Band
- Middle Band (SMA)
- Lower Band
Band Calculations
Middle Band
Calculation:
- 20-period Simple Moving Average
- Base of the indicator
- Shows trend direction
Upper Band
Calculation:
- Middle band + (2 × standard deviation)
- Dynamic resistance
- Expands/contracts with volatility
Lower Band
Calculation:
- Middle band - (2 × standard deviation)
- Dynamic support
- Expands/contracts with volatility
Standard Settings
Default Parameters
Classic Settings:
- Period: 20
- Standard Deviations: 2
Alternative Settings
Tighter Bands:
- 1.5 standard deviations
- More signals
- More noise
Wider Bands:
- 2.5 standard deviations
- Fewer signals
- Extreme captures
Shorter Period:
- 10 periods
- More responsive
- More volatile bands
Band Behavior
Band Width
Expanding Bands:
- Volatility increasing
- After breakouts
- Strong moves
Contracting Bands:
- Volatility decreasing
- Consolidation
- Squeeze forming
Price vs Bands
Normal Behavior:
- Price stays within bands
- About 82% of closes (measured for Forex Trading Strategies, ch. 5, across five majors over ten years; not the 95% usually quoted)
- Outside moves notable
Bollinger Band Signals
Band Touches
Upper Band Touch:
- Strength in uptrend
- Potential resistance in range
- Not automatic sell
Lower Band Touch:
- Weakness in downtrend
- Potential support in range
- Not automatic buy
Band Squeeze
Definition:
- Bands contract significantly
- Low volatility period
- Breakout often follows
Trading:
- Wait for squeeze
- Trade the breakout direction
- Expansion confirms move
Band Expansion
Meaning:
- Volatility increasing
- Strong directional move
- Trend potentially starting
Trading Strategies
Mean Reversion
In Ranges:
- Buy at lower band
- Sell at upper band
- Middle band as target
- Works in sideways markets
Not For Trends:
- Don't fade strong trends
- Bands walk = trending
- Avoid mean reversion then
Bollinger Band Squeeze
Strategy:
- Identify band squeeze
- Wait for breakout
- Enter in breakout direction
- Stop on other side
- Target: band expansion
Squeeze Indicators:
- Bandwidth at low levels
- Visual compression
- Often precedes big moves
Band Walking
Bullish Walk:
- Price rides upper band
- Strong uptrend
- Don't short
Bearish Walk:
- Price rides lower band
- Strong downtrend
- Don't buy
Trading:
- Trade with the walk
- Not against it
- Use pullbacks to middle band
Double Bottom at Lower Band
Pattern:
- First low touches/exits lower band
- Second low stays inside band
- Relative strength
- Potential reversal
M-Top at Upper Band
Pattern:
- First high touches upper band
- Second high fails to reach band
- Relative weakness
- Potential reversal
Bollinger Band Width
The Indicator
Calculation:
- (Upper - Lower) / Middle
- Measures band width
- Shows volatility level
Using Bandwidth
Low Bandwidth:
- Squeeze condition
- Breakout potential
- Historically low = alert
High Bandwidth:
- High volatility
- After big moves
- May contract soon
%B Indicator
Calculation
Formula:
- (Price - Lower Band) / (Upper - Lower)
- Shows where price is in bands
Interpretation
%B > 1: Price above upper band
%B = 0.5: Price at middle band
%B < 0: Price below lower band
Advanced Techniques
Multiple Timeframe
Approach:
- Higher TF bands for context
- Lower TF for entry
- Aligned signals stronger
Bollinger + RSI
Strategy:
- Bands for volatility context
- RSI for momentum
- RSI divergence at bands
Bollinger + MACD
Strategy:
- Bands for range/trend
- MACD for momentum
- Combine signals
Common Mistakes
Auto Buy/Sell at Bands
Mistake: Buy lower band, sell upper band always
Reality: Works in ranges, fails in trends
Ignoring Context
Mistake: Trading bands without trend analysis
Solution: Determine trending vs ranging first
Missing Squeeze
Mistake: Not noticing compression
Solution: Watch bandwidth indicator
Fighting Band Walk
Mistake: Fading strong trend at bands
Solution: Respect band walks
Bollinger Band Checklist
Before Trading
- [ ] Market condition identified (trend/range)
- [ ] Band width assessed
- [ ] Signal type identified
- [ ] Confirmation present
- [ ] Stop loss defined
- [ ] Target set
Band Trading Tips
For Ranges
Do:
- Trade band to band
- Use middle band as exit
- Confirm with oscillators
- Use tight stops
For Trends
Do:
- Trade with band walk
- Use pullbacks to middle band
- Avoid counter-trend
- Let winners run
For Squeezes
Do:
- Wait for expansion
- Trade breakout direction
- Use stop beyond squeeze
- Target measured move
Key Takeaways
- Bands adapt to volatility automatically
- Middle band is 20 SMA, outer bands are 2 std dev
- Squeeze indicates potential breakout
- Band walk indicates strong trend
- Mean reversion works in ranges
- Not automatic buy/sell at bands
- Context determines strategy
- Combine with other analysis
What's Next?
Learn about ATR (Average True Range) for volatility measurement and stop loss placement.
This article is for educational purposes only and does not constitute financial advice.