Bollinger Bands Explained

Bollinger Bands consist of a middle band (typically a 20-period SMA) and two outer bands that are two standard deviations away from the middle. The bands widen when volatility increases and narrow when it decreases. Price tends to revert to the mean (middle band) over time.

The three bands

1. Middle band: 20-period simple moving average.
2. Upper band: Middle band plus 2 standard deviations.
3. Lower band: Middle band minus 2 standard deviations.

Default settings are 20 and 2, but traders sometimes use 50 and 2.1 or other combinations.

When the bands narrow (squeeze), volatility is low. A period of low volatility often precedes a significant move. The squeeze strategy: wait for the bands to narrow, then prepare for a breakout. Enter when price breaks above the upper band or below the lower band with momentum. Use volume or other confirmation if available.

In strong trends, price can ride along the upper band (uptrend) or lower band (downtrend). This is called walking the band. Do not assume mean reversion in these cases. Treat band touches as potential continuation signals when the trend is clear. Combine with trend filters (e.g. ADX, moving averages).

Common strategies

1. Mean reversion: Buy when price touches the lower band, sell when it touches the upper band. Works in ranging markets.
2. Breakout: When price breaks above the upper band with momentum, it may continue. Same for breakdowns.
3. Squeeze: When bands narrow (low volatility), a big move often follows. Prepare for breakout direction.