Bollinger Bands, developed by John Bollinger, plot a volatility envelope around price consisting of a middle moving average and two outer bands set a certain number of standard deviations away. Unlike static support and resistance, the bands expand and contract dynamically with volatility, making them useful for both trending and ranging conditions.
Calculation
Middle band = 20-period SMA; Upper band = SMA + (2 × standard deviation); Lower band = SMA − (2 × standard deviation)The default settings use a 20-period simple moving average and two standard deviations, which statistically should contain roughly 95% of price action under a normal distribution — though real markets deviate from that assumption often enough that band touches are not automatic reversal signals.
The Squeeze
When the bands narrow to an unusually tight width relative to their recent history, it signals a period of compressed volatility — a squeeze. Squeezes frequently precede sharp expansions in price, though the bands themselves do not indicate which direction the eventual move will take. Traders often combine a squeeze with a directional trigger, such as a breakout of the recent range, before entering.
Band Walks in Trends
In a strong trend, price can repeatedly touch or ride along the upper band (in an uptrend) or lower band (in a downtrend) for extended periods without reverting to the middle band. This is called a band walk, and treating every band touch as an automatic reversal signal during a band walk leads to fighting a strong trend.
Two Main Trading Approaches
Mean Reversion
In ranging markets, price tagging the upper band can be treated as relatively overbought and the lower band as relatively oversold, with an expectation of reverting toward the middle band. This works best when the broader market shows no strong directional trend.
Volatility Breakout
Following a squeeze, a decisive close outside a band, especially with expanding band width, can be used as a trend-following entry signal rather than a reversal signal, since it often marks the start of a new directional move.
Because the bands move with volatility and the moving average, price can walk along a band for many periods during a strong trend. Confirm the broader market phase before assuming a band touch means reversal.
Common Mistakes
- ▸Selling every touch of the upper band regardless of whether the market is trending or ranging.
- ▸Ignoring band width and treating a tight squeeze the same as a wide, expanded band environment.
- ▸Using Bollinger Bands in isolation without confirming with trend structure or another momentum indicator.