Bollinger Bands

Name Type Prerequisite Use Cases
Bollinger Bands (BB) Volatility StdDev, SMA Identifying "overextended" prices and volatility squeezes.

Definition

Bollinger Bands are a technical analysis tool defined by a set of trendlines plotted two standard deviations (positively and negatively) away from a simple moving average (SMA) of a security's price. They are used to measure market volatility and identify overbought or oversold conditions.

Mathematical Equation

Bollinger Bands consist of three lines:

Middle Band: A simple moving average (usually 20 periods).

\[ \begin{align} \text{Middle Band} &= \text{SMA}_{20} \\ \text{Upper Band} &= \text{Middle Band} + (2 \times \sigma_{20}) \\ \text{Lower Band} &= \text{Middle Band} - (2 \times \sigma_{20}) \end{align} \]

Where \(\sigma_{20}\) is the standard deviation of the price over the same 20 periods.

Special cases

  • Maximum possible value: Unbounded
  • Minimum possible value: 0
  • Behavior: Follows the price, forming an envelope around it to show volatility and relative price levels.

Visualization

Bollinger_Bands

Trading Significance

  1. Squeeze: When the bands tighten (come closer together), it indicates low volatility and is often followed by a sharp price move (breakout). This is known as a "Squeeze".

  2. Breakputs: A move outside the bands can signal a continuation of the trend, although price often reverts to the mean.

  3. W-Bottoms: A double bottom where the second low is lower than the first but holds above the Lower Band is a bullish sign.

  4. M-Tops: A double top where the high is higher than the first but fails to touch the Upper Band is a bearish sign.

  5. Trend Trading: In a strong uptrend, price tends to hug the Upper Band. In a strong downtrend, price hugs the Lower Band.