Bollinger Bands is a technical indicator used in the analysis of financial markets. It is a volatility indicator that consists of a moving average and two standard deviation lines, one above and one below the moving average. These lines create a channel around the price of an asset, and the width of the channel can be used to gauge the volatility of the asset.
The Bollinger Bands indicator is calculated using the following formula:
- Middle band = Simple moving average (SMA) of the asset’s price
- Upper band = SMA + (standard deviation x a number of deviations)
- Lower band = SMA – (standard deviation x a number of deviations)
The default value for the number of deviations is 2, but this can be adjusted depending on the trader’s preferences.
Traders use Bollinger Bands to identify potential overbought and oversold conditions. When the price of an asset is near the upper band, it is considered overbought and when it is near the lower band, it is considered oversold. Traders can also use the bands to identify potential breakouts or trend reversals by looking for price action outside of the bands.
It’s important to note that Bollinger Bands are a volatility indicator, not a trend following indicator, it also doesn’t predict the price direction. Traders use it in combination with other technical indicators and analysis for making trading decisions.
Additionally, one can also use Bollinger Band width, which is the difference between upper and lower band divided by the middle band, to gauge the volatility of the market. Lower Bollinger Band width indicates lower volatility and higher Bollinger Band width indicates higher volatility in the market.
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