What are Bollinger Bands?
Bollinger Bands (BB) are a technical analysis tool, developed by John Bollinger, used to measure a security’s volatility and potential overbought or oversold conditions. They consist of a simple moving average (SMA) surrounded by two bands plotted at standard deviations above and below the SMA. The bands widen when volatility increases and contract when volatility decreases, providing a visual representation of price fluctuations.
How do they work?
The core principle is that asset prices tend to stay within the bands. A wider band indicates higher volatility, suggesting larger price swings are possible. Conversely, narrower bands suggest lower volatility and potential for a breakout. The SMA acts as a baseline, and price action relative to it helps traders gauge momentum.
Trading Signals
Buy Signal: Price touches or breaks below the lower band, suggesting a potential oversold condition. Sell Signal: Price touches or breaks above the upper band, indicating a potential overbought condition. 'Squeeze' (bands narrowing) often precedes significant price moves. Confirmation with other indicators is crucial.
Basic Settings
The default settings are a 20-period SMA and 2 standard deviations. Traders can adjust these parameters based on the asset and timeframe. Shorter periods react faster to price changes, while longer periods provide smoother signals. Experimentation is key to finding optimal settings. This is for educational purposes only, not financial advice.