Bollinger Bands

In the last lesson we discussed moving averages in the current lesson we are to have a look at the Bollinger bands.

The Bollinger Bands is a technique developed by John Bollinger and is based on Statistics, at which practically two bands are being placed around the 20 period moving average. The upper band would be equal to the 20 period moving average, plus 2 standard deviations, while the lower band is equal to the 20 moving average minus 2 standard deviations.

A standard deviation is a statistical concept that describes how prices are spread around an average value. Using two standard deviations ensures that 95% of the price data will fall between the bands. Bollinger bands measure the volatility of the instrument under study. When the market becomes more volatile, the bands widen, while during quiet periods, the bands contract. The closer the prices move to the upper band, the more overbought the market is. Especially should the price action break above the upper Bollinger band, analysts tend to expect that a correction lower could follow. The closer the prices move to the lower band, the more oversold the market is and should the price action break below the lower band then a correction higher is expected. Traders tend to use the Bollinger bands in a similar way as channels starting to buy when the price action hits the lower boundary and to sell when the price action reached the upper boundary.  Upper and lower bands can also be used as price targets.

In the next lesson we are to discuss oscillators