Bollinger Bands are a volatility indicator that creates dynamic support and resistance levels. They adapt to market conditions, expanding when volatility increases and contracting when it decreases. Here is how to use them.
What are Bollinger Bands?
Bollinger Bands consist of three lines:
- Middle Band: A 20-period simple moving average (SMA)
- Upper Band: Middle band + 2 standard deviations
- Lower Band: Middle band - 2 standard deviations
Key concept: About 95% of price action occurs within the bands. When price touches or goes outside the bands, it is statistically unusual.
What Bollinger Bands Tell You
Band Width = Volatility
- Wide bands = high volatility
- Narrow bands = low volatility
- Low volatility often precedes big moves
Price Position
- Price near upper band = strength, but potentially overextended
- Price near lower band = weakness, but potentially oversold
- Price at middle band = near average, neutral
Bollinger Band Strategies
1. The Squeeze (Breakout Strategy)
When bands contract tightly, a big move is often coming.
- Watch for bands to narrow significantly
- Enter when price breaks out of the squeeze
- Direction of breakout determines trade direction
Squeeze Example
Stock has been trading in a tight range. Bands contract to the narrowest in months.
Price suddenly breaks above the upper band on high volume.
This signals a potential upward breakout. Traders buy the breakout.
2. Mean Reversion (Bounce Strategy)
Price tends to return to the middle band.
- Buy when price touches lower band and starts reversing
- Sell when price touches upper band and starts reversing
- Target the middle band for exits
3. Walking the Bands (Trend Strategy)
In strong trends, price can "walk" along the bands.
- In uptrends, price hugs the upper band
- In downtrends, price hugs the lower band
- Do not fade the trend just because price touches a band
Bollinger Band Rules
- Touching the bands is NOT a signal by itself
- Always wait for confirmation (candlestick pattern, volume)
- Determine the trend first - trade with it, not against it
- Use the middle band as a trailing stop or target
Combining Bollinger Bands with RSI
A popular combination:
- Price touches lower band + RSI oversold = stronger buy signal
- Price touches upper band + RSI overbought = stronger sell signal
- Confirmation from multiple indicators increases probability
Bollinger Band Settings
- 20 period, 2 std dev: Standard, most common
- 10 period, 1.5 std dev: More sensitive, short-term trading
- 50 period, 2.5 std dev: Less sensitive, longer-term trading
Track Your Band-Based Trades
Pro Trader Dashboard helps you analyze which Bollinger Band setups work best for you.
Summary
Bollinger Bands show volatility and potential overbought/oversold conditions. Use the squeeze for breakout trades and band touches for mean reversion. Remember that in strong trends, price can walk along the bands for extended periods. Always use confirmation before trading signals.
Learn more: RSI indicator and implied volatility.