Bollinger Bands are a popular technical analysis tool used by traders and investors to assess the volatility and potential price movements of a financial asset, typically a stock or currency pair. They were developed by John Bollinger in the 1980s and consist of three lines or bands on a price chart
The upper Bollinger Band is typically set two standard deviations above a specified moving average. The moving average used is often a simple moving average (SMA), but it can also be an exponential moving average (EMA). The upper band represents the potential upper price target or resistance level.
The lower Bollinger Band is set two standard deviations below the same moving average used for the upper band. It represents the potential lower price target or support level.
The middle Bollinger Band is the same moving average that the upper and lower bands are based on. It’s often a 20-period SMA, but the period can be adjusted to suit different trading strategies. The middle band provides a reference point for the trend.
The main purposes of Bollinger Bands are –
Volatility Measurement: The width of the Bollinger Bands can be used to gauge the current volatility of an asset. When the bands are narrow, it indicates low volatility, and when they are wide, it suggests high volatility.
Trend Identification: Bollinger Bands can help traders identify the direction of the trend. When the price is consistently trading near the upper band, it may indicate an uptrend. Conversely, when the price is near the lower band, it may indicate a downtrend.
Overbought and Oversold Conditions: Bollinger Bands can be used to identify potential overbought and oversold conditions. If the price touches or crosses the upper band, it may be overbought, suggesting a potential reversal downward. Conversely, if the price touches or crosses the lower band, it may be oversold, indicating a potential reversal upward.
