What Is Bollinger Bands?
Bollinger Bands are a volatility indicator consisting of a 20-day SMA with upper and lower bands 2 standard deviations away. Bands widen in volatility and contract in calm periods.
Definition
Bollinger Bands consist of three lines: a 20-period simple moving average (the middle band) and upper/lower bands plotted 2 standard deviations above and below the SMA. About 95% of price action falls within the bands under normal market conditions.
When volatility increases, the bands widen — price is making large swings. When volatility decreases, bands contract (a 'Bollinger Band squeeze'). A squeeze often precedes a large breakout in either direction. Traders watch for the price to break out of the squeeze as a signal.
Price touching or exceeding the upper band doesn't automatically mean 'sell' — in strong uptrends, price can 'walk the band,' staying near the upper band for extended periods. Bollinger Bands work best when combined with other indicators to confirm signals.
Real-World Example
A stock has been trading in a tight range for 3 weeks — the Bollinger Bands are very narrow (a squeeze). Then the stock gaps up on earnings and closes above the upper band on heavy volume. A momentum trader takes this as a breakout signal, expecting the squeeze to resolve with a sustained upward move.
Why It Matters
Bollinger Bands give a visual representation of volatility and relative price levels — they tell you not just where the price is, but whether the current price is high or low relative to recent volatility.
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Frequently Asked Questions
What does it mean when price touches the upper Bollinger Band?
Price reaching the upper band means it's 2 standard deviations above the 20-day average — statistically extended. In a sideways market, this is a potential sell signal. In a strong uptrend, the price can walk along the upper band for weeks. Context matters — don't sell just because price touches the upper band.
What is a Bollinger Band squeeze?
A Bollinger Band squeeze occurs when the bands narrow significantly, indicating low volatility and a period of price consolidation. Historically, periods of low volatility are followed by periods of high volatility — the squeeze is a coiling spring. The direction of the eventual breakout determines the trade.
What are good Bollinger Band settings?
The default (20, 2) settings are most widely used. Some traders use (10, 1.5) for more signals on shorter timeframes. Changing to 1 standard deviation catches more price touches but with more false signals; wider settings like 2.5 catch fewer touches but those are more extreme moves.
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