Bollinger Bands

Bollinger Bands are a type of trading “envelope” consisting of lines plotted above and below a moving average, which are designed to capture a market’s typical price fluctuations.

The indicator is similar in concept to the moving average envelope, with an important difference: While moving average envelopes plot lines a fixed percentage above and below the average (typically three percent above and below a 21-day simple moving average), Bollinger Bands use standard deviation to determine how far above and below the moving average the lines are placed.

As a result, while the upper and lower lines of a moving average envelope move in tandem, Bollinger Bands expand during periods of rising market volatility and contract during periods of decreasing market volatility.

Bollinger Bands were created by John Bollinger, CFA, CMT, the president and founder of Bollinger Capital Management (see Active Trader, April 2003, p. 60).

By default, the upper and lower Bollinger Bands are placed two standard deviations above and below a 20-period simple moving average.

Upper band = 20-period simple moving average + 2 standard deviations

Middle line = 20-period simple moving average of closing prices

Lower band = 20-period simple moving average - 2 standard deviations

Bollinger Bands highlight when price has become high or low on a relative basis, which is signaled through the touch (or minor penetration) of the upper or lower line.

However, Bollinger stresses that price touching the lower or upper band does not constitute an automatic buy or sell signal. For example, a close (or multiple closes) above the upper band or below the lower band reflects stronger upside or downside momentum that is more likely to be a breakout (or trend) signal, rather than a reversal signal. Accordingly, Bollinger suggests using the bands in conjunction with other trading tools that can supply context and signal confirmation.