What do Bollinger Bands do?

Bollinger Bands are a technical indicator developed by the famous trader John Bollinger in the 1980s as a way of visually representing volatility on a price chart. Bollinger Bands are created by plotting a 20-day simple moving average, and then bracketing that with a line one deviation away on each side. Because they are easy to plot and use Bollinger Bands have become very popular among technical traders. They tell traders when markets may be getting overbought and oversold based on where price is relative to the upper and lower bands. They are also used together with other technical indicators to provide confirmation for trades. You can see Bollinger Bands in action below. Because they measure volatility you will notice how the bands widen as volatility increases, and narrow when volatility drops.

Bollinger Band Squeeze

The Bollinger Band squeeze is one of the central concepts in using Bollinger Bands. The squeeze simply describes when the bands come closer together and “squeeze” the moving average. This squeeze tells traders volatility is dropping, and that it isn’t a good time to trade now, but that future volatility will give trading opportunities. Once the bands begin moving further apart traders know volatility is picking up. Note that the squeeze itself is not a trading signal and gives no clue as to which direction price might move.

Bollinger BandBreakouts

Because roughly 90% of price action happens between the bands it’s a major event when price breaks outside the bands. However, a breakout is not a trading signal. Breakouts by themselves give no indication of future price.

Bollinger Band Limits

As mentioned above, Bollinger Bands do not give any indications of future price, and thus are not suitable to be used as a standalone trading system. Instead they are meant to be combined with other non-correlated indicators that provide different types of data. The Bollinger Bands give traders information about price volatility.  Some good indicators to combine the Bollinger Bands with include the relative strength index or MACD. At the end of the day, no indicator is perfect by itself, and the Bollinger Bands are no different. They can be very useful in providing price volatility information, and when used with other non-correlated technical indicators may give investors a greater chance of success.