Overlays · Indicator
Bollinger Bands wrap a moving average in standard-deviation bands that widen when volatility rises and contract when it falls.
Overview
Bollinger Bands, developed by John Bollinger, plot three lines: a middle simple moving average with upper and lower bands set at plus and minus two standard deviations. Because the standard deviation is recalculated on every bar, the bands are not a fixed distance from the average. Band width expands in high volatility and contracts in low volatility, so the envelope adapts to the instrument and the moment rather than assuming a constant range.
That adaptiveness is what makes the bands useful. A five-point move means something different in a market that has been moving twenty points a day than in one that has been moving two. By expressing distance from the average in standard deviations, the bands put every instrument and every volatility regime on a comparable footing. Prices near the outer bands can signal overbought or oversold conditions, meaning price has become statistically stretched relative to its own recent behaviour.
It is worth being precise about what 'overbought' means here. Touching the upper band does not mean price is too high in any absolute sense; it means price is roughly two standard deviations above its recent average. In a strong trend price can ride the upper band for many bars in a row, and each of those bars is statistically extreme while the trend continues perfectly happily. The bands describe position within a distribution, not a forecast.
How it is calculated
The middle band is a simple moving average of the chosen source over the chosen length. The standard deviation is then computed over the same window, measuring how far the source has typically strayed from that average, and the outer bands are placed a multiple of that deviation above and below.
Because the standard deviation uses squared differences, a single large bar has an outsized effect and can push the bands wide for the whole length of the window before dropping out. The bands need the full window before they print, so the first values appear at bar N.
Basis = SMA(source, length) Deviation = standard deviation of source over the last length bars Upper = Basis + multiplier * Deviation Lower = Basis - multiplier * Deviation Bandwidth = (Upper - Lower) / Basis
Inputs
How to read it
Start with the width. Bands squeezing to an unusually narrow range say volatility has compressed, which historically tends to be followed by an expansion, though the bands give no indication of which direction that expansion takes. Bands at an unusually wide setting say the market has already moved a great deal, which is often closer to the end of a move than the start.
Then read where price sits inside the envelope. Sustained closes in the upper half with the middle band rising describe an uptrend; the middle band itself often acts as support on pullbacks in that condition. Price oscillating from one band to the other around a flat middle band describes a range, and that is the condition in which band touches are most often followed by a move back towards the average.
The bands are most misread in trends. In a strong advance, price hugging the upper band is a sign of strength, not a sell signal, and repeatedly fading those touches is a reliable way to fight a trend. Traders generally use the slope of the middle band to decide whether they are in a mean-reverting regime, where band touches are worth fading, or a trending one, where they are not.
Signals to look for
Bandwidth contracting to the low end of its recent range marks a volatility compression. Traders mark the boundaries of the consolidation and watch for an expansion bar to show direction, because the squeeze itself is directionally neutral.
A sequence of closes outside or along the upper band with the middle band rising is read as trend strength rather than exhaustion. The same pattern along the lower band describes a strong downtrend.
In a trend, a retracement into the rising middle band that holds and then resumes is a common continuation reference, because the middle band is simply the 20-period average most participants also watch.
A second low that undercuts the first in price but does not reach as far outside the lower band describes selling that is losing force relative to volatility. The mirror pattern at highs is the M-top. Both require confirmation from price structure.
Limitations
Frequently asked questions
Bollinger Bands wrap a moving average in standard-deviation bands that widen when volatility rises and contract when it falls.
Start with the width. Bands squeezing to an unusually narrow range say volatility has compressed, which historically tends to be followed by an expansion, though the bands give no indication of which direction that expansion takes. Bands at an unusually wide setting say the market has already moved a great deal, which is often closer to the end of a move than the start.
The squeeze: Bandwidth contracting to the low end of its recent range marks a volatility compression. Traders mark the boundaries of the consolidation and watch for an expansion bar to show direction, because the squeeze itself is directionally neutral.
The bands assume price deviations behave in a roughly bell-shaped way, and financial returns do not. Extreme moves occur far more often than a normal distribution implies, so a three-sigma excursion is not the rarity the statistics suggest.
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