Bollinger Bands are overlaid on top of the price charts. The upper and lower bands mark the price statistical standard deviations from the average price. The spacing between the bands varies based on the volatility of the prices. The band tends to become wider when there is an extreme price changes (High Volatility) and it becomes narrow during stagnant pricing (Low Volatility) periods.
The application of Bollinger Bands is summarized in below mentioned situations:
- The current price trend will continue if prices move outside of the bands.
- There could be a trend reversal if bottoms and tops are made outside of the band, then followed by bottoms and tops made inside of the band.
If there is any origination of move at one band tends to go all the way to the other band. This observation could be useful, when we are projecting the price targets.
Chart: Bollinger Bands overlaid on Exxon’s (XOM) Price Chart, 1 Day. Timeframe: 5 Minute Bars.
Bollinger Bands can be categorized into a set of three bands.
- Middle Band: The middle band is a normal moving average.
Where “n” is the number of time periods in the moving average (for example 20 days).
- Upper Band: The upper band is same as the middle band, but it is shifted up by the number of standard deviations.
Where “D” is the number of standard deviations.
- Lower Band: The lower band is the moving average shifted down by the same number of standard deviations (i.e. “D”).
Mr. Bollinger recommends using “20” for the number of periods in the moving average, the moving average using the “Simple” method and using 2 standard deviations.