Bollinger Bands

In simple terms

Bollinger Bands, created by the analyst John Bollinger, draw an envelope around a moving average. The envelope widens when prices swing a lot and narrows when they are calm.

The standard deviation measures how spread out the recent prices are around their average, as the averages and volatility lesson explains.

A worked example

Band width and volatility

Band width, the distance between the bands as a percentage of the middle band, is a simple measure of recent volatility. Wide bands follow large swings; narrow bands follow quiet periods.

A very narrow period is often called a squeeze. Volatility tends to change over time, so quiet periods are often followed by more active ones. But the squeeze does not tell you which direction the next move will take: prices can break out upward, downward, or stay quiet for longer.

Touching a band is not a signal

A popular idea is that a price touching the upper band is "too high" and should fall back, and one touching the lower band is "too low". This rests on a statistical idea: if price changes followed a normal distribution, about 95% of closes would fall inside two standard deviations of the average.

Two problems:

1. Prices are not normally distributed. Large moves happen far more often than a normal distribution predicts, as the tail risk idea suggests. So prices leave the bands more often than "5% of the time".
2. In trends, the bands follow the price. During a strong rise, closes cluster near the upper band, which itself keeps rising. Prices can "walk the band" for weeks.

In sideways markets, prices more often turn back from the bands, which is why some traders use band touches differently depending on whether the market is trending or ranging. Telling the two apart in real time is the difficult part.

Using the bands sensibly

• As a volatility gauge: band width shows whether the market is calm or active.
• As context for where the price sits relative to its recent range.
• Not as automatic buy or sell signals.

Why it matters

Bollinger Bands are popular because they adapt to volatility, which fixed-percentage bands do not. Understanding the calculation, and the statistical assumption behind the "two standard deviations" idea, protects you from the common mistake of treating band touches as reversal signals.

Limitations

The bands depend on the period and the multiple chosen; the standard 20 and 2 are conventions. They lag, because they are built on a moving average and a backward-looking standard deviation. And their statistical interpretation assumes a normal distribution that price changes often do not follow.

Common mistakes

• Selling every touch of the upper band.
• Assuming 95% of prices stay inside the bands.
• Predicting the direction of a breakout from a squeeze.
• Forgetting that the bands lag.

Try it yourself

1. Take 20 closing prices for any share and calculate their average and standard deviation in a spreadsheet.
2. Calculate the upper and lower bands and the band width.
3. On a charting tool, add Bollinger Bands to a daily chart and find a period of strong trend.
4. Count how many closes touched or crossed the outer band during that trend.