Bollinger Bands are a specific type of trading indicator used for technical analysis. They are displayed on a chart as bands around a security’s price. These bands adjust based on volatility, which helps traders assess if a security is overbought or oversold.
Here’s a deeper look at Bollinger Bands:
- Mechanics:
- Bollinger Bands consist of three lines:
- A middle band, which is a simple moving average of the security’s price.
- An upper band, plotted a certain number of standard deviations above the middle band.
- A lower band, plotted the same number of standard deviations below the middle band. (The most common setting is two standard deviations).
- As the price fluctuates, the bands widen or contract to reflect the changing volatility.
- Bollinger Bands consist of three lines:
- Interpretation:
- The general idea is that Bollinger Bands create a zone where statistically, the price is likely to stay most of the time.
- When the price moves near the upper band, it suggests the security might be overbought, potentially indicating a price retracement or reversal.
- Conversely, a price near the lower band suggests a potentially oversold condition, which could signal a bounce or upward move.
- The width of the bands is another indicator. Narrow bands suggest low volatility, while wide bands indicate high volatility.
- Things to Consider:
- Bollinger Bands alone are not a perfect trading tool. They should be used in conjunction with other technical indicators and analysis.
- Reaching the bands doesn’t guarantee a reversal. Prices can break through the bands and continue trending.
