What is Bolinger Bands
How to Calculate Bollinger Bands
What Do Bollinger Bands Tell You?
Example of Bollinger Bands
Limitations of Bollinger Bands
Bollinger Bands FAQs
What is Bollinger Bands?
Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. They are designed to discover opportunities that give investors a higher probability of correctly identifying when an asset is oversold or overbought.
How to Calculate Bollinger Bands
Bollinger Bands consist of three lines:
Middle Band: This is a simple moving average (SMA) that usually uses 20 periods.
Upper Band: This is calculated by adding two standard deviations (a statistical measurement of variance in a set of data) to the middle band.
Lower Band: This is calculated by subtracting two standard deviations from the middle band.
What Do Bollinger Bands Tell You?
Bollinger Bands provide insights into potential price levels where an asset may experience resistance or support, and they can help identify market volatility and price levels that are potentially overbought or oversold. The price of the asset is considered overbought when it is near the upper band and oversold when it is near the lower band.
A common strategy using Bollinger Bands is to identify “squeezes”, periods when the bands come closer together, signaling reduced volatility. Traders anticipate a significant price movement or “breakout” following a squeeze.
Example of Bollinger Bands
Suppose a stock’s 20-day moving average is $50, and the standard deviation is $5. In this case, the upper band would be at $60 (50 + (25)), and the lower band would be at $40 (50 – (25)). If the stock price rises to $60, the stock could be considered overbought as it has reached the upper band. Similarly, if the stock price falls to $40, it could be considered oversold.
Limitations of Bollinger Bands
While Bollinger Bands can be a helpful tool, they have their limitations. For example:
Not Definitive: Prices can move along the bands for extended periods without reaching the middle band or reversing. Therefore, the fact that the price is near the upper or lower band doesn’t definitively indicate that it is overbought or oversold.
Dependent on Market Conditions: In trending markets, prices can continually hug the upper or lower band, leading to multiple false signals for reversals.
Requires Complementary Tools: Bollinger Bands do not provide signals for trend direction or momentum. Therefore, they are often used in combination with other technical analysis tools.
Bollinger Bands FAQs
Do Bollinger Bands work in both swing trading and intraday trading?
Yes, they can be used in multiple trading styles and over different time frames.
How do you read Bollinger Bands?
When the price approaches the upper band, the asset may be considered overbought; when it approaches the lower band, it may be considered oversold. The narrowing of the bands (a “squeeze”) suggests decreased market volatility and potential for a breakout, either up or down.
Can Bollinger Bands be used for any asset?
Yes, they can be applied to any market and any asset that has a standard deviation.
How reliable are Bollinger Bands?
Like any other tool in technical analysis, they are not 100% accurate and should be used in conjunction with other tools and information.
