Introduction
Bollinger Bands plot trading bands above and below a simple moving average. The standard
deviation of closing prices for a period equal to the moving average employed is used to
determine the band width. This causes the bands to tighten in quiet markets and loosen in
volatile markets. The bands can be used to determine overbought and oversold levels,
locate reversal areas, project targets for market moves, and determine appropriate stop
levels. The bands are used in conjunction with indicators such as RSI, MACD histogram, CCI
and Rate of Change. Divergences between Bollinger bands and other indicators show
potential action points.
The middle band is a normal moving average. In the following formula, "n" is the
number of time periods in the moving average (e.g., 20 days).
The upper band is the same as the middle
band, but it is shifted up by the number of standard deviations (e.g., two deviations). In
this next formula,
where D is the number of standard
deviations.
The lower band is the moving average shifted
down by the same number of standard deviations (i.e., "D").
A sample of an Analytical chart showing
bollinger bands is depicted in the following figure:
