Bollinger Bands® was invented by John Bollinger in the 1980s but it was only trademarked in 2011. It is a technical analysis tool that measures volatility of stocks through analyzing the relative high and low prices of stocks. It uses two standard deviations from a simple moving average as a band where technical traders can determine whether the markets care more or less volatile. The simple moving average used is usually the 20-day moving average of the stock. But simple moving averages can be modified to suit a specific trading style.
It is computed as follows:
BOLU = Upper Bollinger Band®
BOLD = Lower Bollinger Band®
n = Smoothing Period
m = Number of Standard Deviations (SD)
SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3
BOLU = MA(TP, n) + m * SD[TP, n]
BOLD = MA(TP, n) – m * SD[TP, n]
However, there are many websites that offer tools that reflect stock prices and technical indicators such as Bollinger Bands.
In the chart above, the center line is the simple moving average and two price channels above and below the center line are the Bollinger Bands.
If the Bollinger Band moves further away from the average, the market conditions are more volatile. On the other hand, if the Bollinger Band approaches the average, the market conditions are less volatile.
If the price follows the lower band, there is bullish divergence and the stock is oversold. If the price follows the upper band, there is bearish divergence and the stock is overbought.
If the price average touches the lower band, this is a signal to SELL. If the price average touches the upper band, this is a signal to BUY.
Bollinger Bands are useful not only for stock analysis but also for options analysis. Many technical traders find it easy to interpret and very helpful in crafting short-term strategies. As mentioned above, it is fairly easy to diagnose the stock’s behavior against the market using the Bollinger Bands and that makes it one of the most popular technical analysis tools. However, Bollinger Bands are more effective when used with other useful technical indicators.
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