Bollinger Bands

Introduction

Bollinger BandsBollinger BandsA volatility indicator consisting of a simple moving average (typically 20 periods) and two standard deviation bands plotted above and below the SMA.Read full glossary entry → are a highly popular technical analysis tool developed by John Bollinger in the early 1980s. They consist of three lines plotted directly on the price chart: a middle line (usually a Simple Moving Average) and two outer bands representing standard deviations of the price. The bands expand and contract dynamically based on market volatility.

Why It Matters

• Volatility Filter: Visualizes when the market is transitioning from quiet consolidation to active trendTrendThe general direction in which a security or market is moving over time.Read full glossary entry → expansion.
• Relative Price Levels: Helps traders evaluate whether price is relatively high (at the upper band) or relatively low (at the lower band).
• Mean Reversion Trades: Highlights logical target areas for pullbacks inside trading ranges.

Formula Explanation

Bollinger BandsBollinger BandsA volatility indicator consisting of a simple moving average (typically 20 periods) and two standard deviation bands plotted above and below the SMA.Read full glossary entry → are composed of three lines calculated as follows:

1. Middle Band

2. Upper Band

3. Lower Band

Volatility Expansion vs. Contraction

• The Squeeze (Contraction): When volatility drops to low levels, the outer bands contract toward the middle line. This indicates compression, and is a strong warning that a high-volatility breakoutBreakoutA price movement through an established support or resistance level. A breakout is often accompanied by increased volume, signaling strong momentum.Read full glossary entry → is imminent.
• The Expansion: When price breaks out of the range, the bands expand outward. During a strong trendTrendThe general direction in which a security or market is moving over time.Read full glossary entry →, the price will often close repeatedly above the upper band (or below the lower band)—a behavior known as "walking the bands."

Trading Setup

The Squeeze Breakout Entry

1. Identify the Squeeze: Look for the bands to narrow to their tightest width in recent sessions (horizontal consolidation).
2. Identify the BreakoutBreakoutA price movement through an established support or resistance level. A breakout is often accompanied by increased volume, signaling strong momentum.Read full glossary entry →: Wait for a daily candle to close cleanly outside the bands (e.g. above the Upper Band for a bullish breakout).
3. Verify with VolumeVolumeThe total number of shares, contracts, or units of a security traded during a specified time period.Read full glossary entry →: Confirm that the breakout candle is supported by high volumeVolumeThe total number of shares, contracts, or units of a security traded during a specified time period.Read full glossary entry → (at least 1.5x average).
4. Entry: Enter long on the close of the breakout candle. Place a stop-loss orderStop-Loss OrderAn order placed with a broker to sell an asset when it reaches a specific price, designed to limit a trader's loss on a position.Read full glossary entry → just below the middle SMA line. Exit when the price closes back below the middle band.

Common Beginner Mistakes

[!WARNING]

• Buying Touches Automatically: Assuming that touching the upper band is an automatic sell signal, or touching the lower band is an automatic buy signal. In strong trends, price can "walk" the band for a long period, causing massive losses for counter-trend traders.
• Trading Squeezes Without Volume: Entering a squeeze breakout on low volume, which often leads to fakeouts (bull or bear traps).
• Ignoring the Major Trend Context: Buying lower band touches in a macro downtrendDowntrendA market direction characterized by a sequence of lower highs and lower lows.Read full glossary entry →, where the price is likely to continue dropping.