Bollinger Bands
Key Takeaways
- 01.Composed of a central SMA and two volatility bands based on standard deviation.
- 02.Bands expand during high volatility and contract during low volatility.
- 03.A Bollinger Squeeze (contracted bands) often precedes a major price breakout.
- 04.Prices are considered relatively high at the upper band and relatively low at the lower band.
Why it matters
It provides a dynamic definition of high and low: 95% of price action typically occurs within the bands. It helps identify mean-reversion trades (selling the upper band, buying the lower band) in range-bound markets, or breakout expansion trades (trading a Bollinger Squeeze).
When it matters
It is useful across all timeframes. Squeezes are highly watched on daily and weekly charts before major corporate announcements or earnings.
An envelope of three lines surrounding the price candles, expanding and contracting as price volatility changes.
Apply Bollinger Bands to the chart to observe how the price behaves when it touches the upper or lower band.
Common Mistakes
Treating upper/lower band touches as automatic signals
A touch of the upper band is not a sell signal, nor is a touch of the lower band a buy signal. In a strong trend, price can 'walk the band', clinging to the upper or lower line for extended periods while moving higher or lower.
📖 Real-World Example: A classic volatility squeeze
A major bank's daily chart showed Bollinger Bands contracting to their tightest range in two years. This squeeze lasted for two weeks. Following a dividend announcement, the price broke above the upper band on massive volume, initiating a 20% rally as the bands expanded rapidly.