Bollinger Bands are a form of a technical indicator which highlight trading ranges on a price chart. These bands help to identify market volatility and determine overbought and oversold levels and more. These bands can be used for various asset classes to consider price fluctuations and determine trends in the market.
These trading bands are plotted above and below a simple moving average. There are two terms that need to be understood: standard deviation and moving average. While the standard deviation depicts the measure of dispersion from the mean in a data set, a moving average is an average of closing prices in a timeframe that can aid in identifying a trading opportunity.
The technical indicator comprises three lines: the upper band, lower band and middle band. While the upper and lower bands signify standard deviations of a particular stock, the middle band indicates the simple moving average. The combination of these three structures produce a price envelope.
Bollinger Bands can be interpreted this way: In case a particular stock’s price is closer to the upper band, such a stock is considered overbought. On the other hand, in case the stock’s price is closer to the lower band, it is regarded as oversold.
Then, if the upper and lower Bollinger Bands contract and move closer to the moving average, then the bands tend to become narrows, which indicates that there is not much volatility in the stock market. Similarly, if the Bollinger Bands widen, the prices showcase the volatility.
However, Bollinger Bands alone do not provide exact trading signals. In a scenario where the price of a particular stock is at the lower Bollinger Band, a trader should potentially identify the overall trend of the stock. Followed by looking for any price action, which could be a reversal candlestick pattern.
Ideally, a trader must consider other indicators as well to gain thorough understanding of the market before making the jump to buy or sell a stock.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.