What it is and how to use it
What is it?
Bollinger Bands are a versatile and popular technical analysis tool. They consist of three lines: a middle band, which is a simple moving average, and two outer bands, which are standard deviations away from the middle band. These bands expand and contract based on market volatility, helping traders identify potential overbought or oversold conditions, as well as price breakouts.
Who made it?
Bollinger Bands were created by John Bollinger in the early 1980s. Bollinger, a prominent financial analyst and author, introduced this tool as a way to measure market volatility and provide relative definitions of the high and low prices of a market.
How is it calculated?
The Bollinger Bands are calculated as follows:
Middle Band: This is a simple moving average (SMA) of the closing prices over a specified period.
Upper Band: The middle band plus two times the standard deviation (SD) of the closing prices over the same period.
Lower Band: The middle band minus two times the standard deviation (SD) of the closing prices over the same period.
Code (ProRealTime)
How do you use it?
Bollinger Bands are used in several ways to make trading decisions:
Overbought/Oversold Conditions:
When the price touches or moves beyond the upper band, it may indicate an overbought condition. Conversely, when the price touches or moves below the lower band, it may indicate an oversold condition.
Volatility Breakouts:
A squeeze, where the bands come close together, indicates low volatility and potentially precedes a significant price move. A breakout from this squeeze can signal the start of a new trend.
Trend-Following:
If the price consistently hits the upper band during an uptrend or the lower band during a downtrend, it can confirm the strength of the trend.
Mean-Reversion:
Prices tend to revert to the mean, or the middle band, after touching the upper or lower bands. This concept is often used in mean-reversion trading strategies.
FAQ
Q: What are the best settings for Bollinger Bands?
A: The default settings for Bollinger Bands are a 20-period moving average with bands set at 2 standard deviations above and below the moving average. You can adjust these settings based on your trading style and market conditions.
Q: How does Bollinger Bands compare to the Keltner Channel?
A: Bollinger Bands use standard deviation to set the bands, making them more responsive to volatility changes. Keltner Channel uses the ATR, which results in smoother bands. Both indicators identify overbought and oversold conditions, but they calculate their bands differently.
Q: What are the strengths and weaknesses of Bollinger Bands?
A: Bollinger Bands are effective in identifying volatility and potential reversal points. However, they can be prone to false signals in trending markets without additional confirmation from other indicators.
Strategies using the Bollinger Bands indicator
None so far.