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Understanding Bollinger Bands: A Guide for Investors

Updated: Feb 9


One of the most widely used technical indicators by traders and investors is the Bollinger Band. The Bollinger Band was developed by John Bollinger in the 1980s as a tool to gauge volatility and predict price levels that are potentially overbought or oversold. It provides a relative definition of high and low prices of a market.


Basics of Bollinger Bands


A Bollinger Band is a volatility indicator that includes three lines: a simple moving average (SMA), an upper band, and a lower band. Typically, the SMA is set to 20 periods, with the upper and lower bands representing two standard deviations away from the SMA. These settings can, of course, be adjusted to better fit the trader's style or the characteristics of the security. The principle behind Bollinger Bands is that the price of a security will always return to its mean or average price, despite periods of volatility and price swings. Bollinger Bands capitalize on this principle by providing a framework that adds and subtracts a standard deviation calculation from the moving average of a security's price, thus creating a 'band' of dynamic support and resistance levels.


Chart illustrating Bollinger Bands



  • The blue line represents the stock price over 200 days.

  • The black line represents the simple moving average.

  • The red line represents the upper Bollinger Band, set two standard deviations above the moving average.

  • The green line represents the lower Bollinger Band, set two standard deviations below the moving average.

  • The orange shaded area between the red and green lines represents the range within the Bollinger Bands.


Interpreting Bollinger Bands


  • Identifying overbought and oversold conditions: When prices continually touch the upper Bollinger Band, the market may be considered overbought, while touching the lower band may indicate an oversold market. However, these conditions alone are not a sufficient indicator to buy or sell. Instead, they signal that a trader should further investigate other indicators and market dynamics.

  • Squeeze: When the bands come close together, constricting the moving average, it is called a squeeze. A squeeze signals a period of low volatility and is considered by traders to be a potential sign of future increased volatility and possible trading opportunities.

  • Expansion: Conversely, when the bands expand, this is an indication of an increase in volatility, or an "expansion." It could potentially indicate the start of a new trend.

  • Riding the Bands: In a strong uptrend, prices usually oscillate between the upper band and the moving average, and in a downtrend, prices will be between the lower band and the moving average.


Practical Examples


Consider the stock of Company XYZ. If the 20-day moving average of the stock is $30, and the standard deviation of the stock over the past 20 days is $1.50, the upper and lower Bollinger Bands will be calculated as follows:


  • Upper Bollinger Band = SMA + (2 x standard deviation) = $30 + (2 x $1.50) = $33

  • Lower Bollinger Band = SMA - (2 x standard deviation) = $30 - (2 x $1.50) = $27



If the stock price of XYZ increases to $33.50, it is above the upper Bollinger Band. This could indicate that the stock is overbought and due for a pullback. However, investors should look for additional signs to confirm this. Similarly, if the stock price drops to $26.50, it is below the lower Bollinger Band. This may signal the stock is oversold and could be due for a price bounce. Again, other indicators should also be consulted to confirm this signal.


  • The blue line represents the stock price over 200 days.

  • The black line represents the simple moving average.

  • The red line represents the upper Bollinger Band, set two standard deviations above the moving average.

  • The green line represents the lower Bollinger Band, set two standard deviations below the moving average.

  • The orange shaded area between the red and green lines represents the range within the Bollinger Bands.

  • The dark red points represent when the price exceeds the upper band, which could indicate overbought conditions.

  • The dark green points represent when the price falls below the lower band, which could indicate oversold conditions.


The Caveats


Bollinger Bands are a powerful tool, but like all indicators, they must be used as part of a larger trading plan. They are best used in conjunction with other indicators or methods to confirm signals and prevent false alarms. Overreliance on Bollinger Bands can lead to mistakes if the broader market context isn't taken into consideration. Also, it's crucial to remember that during periods of extreme volatility, price can move very rapidly towards or even beyond the bands. Therefore, seeing a price touch or exceed a band doesn't necessarily mean a reversal is imminent.


Bollinger Bands are an excellent tool for understanding volatility and predicting potential price movements. They can help identify overbought and oversold conditions, predict periods of increased volatility, and provide dynamic support and resistance levels. But like all indicators, they should not be used in isolation. Properly applied and interpreted within a broader trading or investment strategy, Bollinger Bands can help investors make informed decisions and increase their chances of trading success.

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