Bollinger Bands Indicator

Bollinger Bands were invented in 1980 by John Bollinger as a technical analysis instrument. This indicator can give large amounts of information indicating buy and sell signals, continuation signals, periods of consolidation, periods when a currency is overextended and can establish price targets.

Very similar to the Moving Average Envelope indicator, Bollinger Bands Indicator forms an upper band and a lower band around the moving average. The difference between those two indicators is that Bollinger Bands use the concept of standard deviation for the upper and lower bands.

Usually for the middle band is used a simple moving average but can be used other types of averages like the exponential moving average. The interval between the middle band and the upper and lower bands is determined by volatility, typically the standard deviation of the same data that were used for the average. The default parameters used in Bollinger Bands indicator are 20 periods and 2 standard deviations but they can be adjusted to suit the purposes.

Standard deviation is the mathematical formula that measures volatility, showing how the price can vary from its true value. Bollinger Bands adjust themselves to market conditions by measuring the price volatility so when the volatility is high the Bands widen and when the volatility is low the Bands shrink.

Bollinger Bands that are very narrow indicate a period of consolidation and can be a signal that a breakout might come soon. The longer the price stays within narrow bands the grater is the chance of a breakout.

If the Bollinger Bands are far apart it can be a signal that a reverse trend can occur soon. According to the theory of normal distribution when prices reach an extreme level the trend reverses. Prices close above the upper band and below the lower band are signs of trend continuation and should not be interpreted as reversal signals. Prices can ride the upper band in an uptrend and can ride the lower band in a downtrend.

A price touching the upper band can suggest that the currency is overbought meanwhile a price touching the lower band indicates that the currency pair is oversold.

If the price is turning into the opposite direction after touching one of the bands can be a signal of reversal. In order to be sure of the reversal the trader should wait price to cross over the moving average.

The overbought and oversold guidelines can be used as resistance and support lines.
A bullish signal can appear if the price penetrates the lower band once, rebounds and forms another low but above the lower band (“double bottom”). When the price moves across the moving average the signal is confirmed.

The bearish signal appears when the price peaks above the upper band and then develops a second peak that stays below the upper band (“double top”). The bearish signal is also confirmed if the price crosses over the middle band.

These are just few ways on how to use the Bollinger Bands indicator. Like all others technical analysis indicators must not be used alone. Bollinger Bands work best combined with indicators that measure volume and momentum.