Bollinger Bands

Bollinger Bands, developed by John Bollinger, measure volatility and put the current price in context relative to its recent range. They wrap price in an envelope that expands and contracts as the market becomes more or less turbulent, which makes them a distinctive and useful addition to the indicators you have met so far. They also give you a first real use of standard deviation, which you will study formally in Unit 5.

The three lines

Bollinger Bands are three lines plotted on the price chart. The middle band is a moving average, conventionally a twenty-period simple moving average. The upper band and lower band are placed a certain number of standard deviations above and below the middle band, conventionally two standard deviations. Because standard deviation measures how spread out price has been, the bands respond directly to volatility.

Volatility makes them breathe

The defining feature of Bollinger Bands is that they widen and narrow with volatility. When the market becomes more volatile and price swings grow larger, the standard deviation increases and the bands spread apart. When the market calms and price swings shrink, the standard deviation falls and the bands contract. The distance between the bands is therefore a direct visual measure of how turbulent the market currently is, which fixed-width tools cannot show.

The squeeze

A particularly watched condition is the Bollinger squeeze, when the bands contract to an unusually narrow width. A squeeze indicates a period of low volatility, and since markets tend to alternate between calm and active phases, a prolonged squeeze is often read as a coiling that may precede a significant move. The squeeze tells you that volatility is low and may be about to expand, though it does not tell you which direction the eventual move will take.

Bollinger Bands measure how much price is swinging. When they pinch tight, a quiet stretch often comes before a bigger move.

The misconception to avoid

A common mistake is to treat a touch of the upper band as an automatic sell signal and a touch of the lower band as an automatic buy. This is wrong in exactly the same way the RSI thresholds can mislead. In a strong trend, price can ride along the upper band for a while, a behavior called walking the band, climbing the whole time. Touching a band tells you price is high or low relative to its recent range, not that it must reverse. As always, the bands are best used for context and in combination with other evidence, not as a mechanical trigger.

Bollinger Bands add volatility to your reading of a chart. But every indicator so far is built from price alone. The next lesson brings in the other primary data source, volume.