What it is:

Bollinger Bands consist of three plots (white dotted lines in Figure 1).

Figure 1

The middle line is a 21 period exponential moving average plot of price.

The topmost line is a +2 standard deviation plot of the 21 period moving average of price.

The bottommost line is a -2 standard deviation plot of the 21 period moving average of price.

The chart shown in Figure 1 was selected specifically to show how the Bollinger Bands can expand and contract over time as price volatility changes.

What it tells us:

The greatest majority of trades take place between the top and bottom Bollinger Bands.

Trading outside the Bollinger Bands is predictive of a potential change in price direction.

Widening of the Bollinger Bands is indicative of a strong current price movement – and may indicate a change in direction will happen in the near future.

Narrowing of the Bollinger Bands is indicative a consolidation in price and may indicate a strong movement once the consolidation breakout occurs.

How we use it:

We use Bollinger Bands for trend direction and trend strength indication.

We also use Bollinger Bands to indicate the trading range of price for the specific timeframe being viewed.

We use Bollinger Bands in predicting price reversal of direction. Most price reversals occur very near a Bollinger Band.

There are many other subtleties to using Bolli9nger Bands, but these are the most relevant to our trading method.

One last parting comment on the chart above: we captured it while writing this post and are not sure where price will go from here in this market. However, because price has been in the upper area of the Bollinger Bands for a great amount of time, we would definitely be watching this market for a price reversal in the foreseeable future – but the current trend is up and strong – so we would need a pretty good indication of a reversal before we shorted this market.

 

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