What are Bollinger Bands (BB)?

Bollinger Bands (BB) are a widely popular technical analysis instrument created by John Bollinger in the early 1980s. Bollinger Bands consist of a band of three lines that are plotted about security prices. The line in the middle is usually a Simple Moving Average (SMA) set to a period of 20 days (the type of trend line and period can be changed by the trader; however, a 20-day moving average is the most popular). The SMA then serves as a base for the Upper and Lower Bands, which are used to measure volatility by observing the relationship between the Bands and price. Typically, the Upper and Lower Bands are set to two standard deviations away from the SMA (The Middle Line); however, the trader can also adjust the number of standard deviations.

Bollinger Bands consist of a band of three lines that are plotted about prices.

The three lines:

  1. Upper Band
  2. Middle Line
  3. Lower Band

The line in the middle is usually a Simple Moving Average (SMA) set to 20 days.

The SMA then serves as a base for the Upper and Lower Bands.

The Upper and Lower Bands are used to measure volatility by observing the relationship between the Bands and price.

Typically, the Upper and Lower Bands are set to two standard deviations away from the SMA (The Middle Line), but the trader can usually adjust.

As volatility increases, the wider the bands become. Likewise, as volatility decreases, the gap between bands narrows.

Limitations of Bollinger Bands®

Bollinger Bands® is not a standalone trading system. They are simply one indicator designed to provide traders with information regarding price volatility. John Bollinger suggests using them with two or three other non-correlated hands that provide more direct market signals. He believes it is crucial to use arrows based on different types of data. Some of his favored specialized techniques are moving average divergence/convergence (MACD), on-balance volume, and relative strength index (RSI).

Because they are computed from a simple moving average, they weigh older price data the same as the most recent, meaning that outdated data may dilute new information. Also, using 20-day SMA and two standard deviations is arbitrary and may not work for everyone in every situation. Traders should adjust their SMA and standard deviation assumptions accordingly and monitor them.