Bollinger Bands are easily recognized by a pair of trading bands that represents the upper and lower trading ranges in which the stock is said to trade.
Two Effective Bollinger Band Trading Strategies
1. The Reversal Strategy – Although a simple strategy, the reversal method remains highly effective. The reversal will become clear when a candlestick breaks out of the upper or lower Bollinger bands. When this happens, you can take a short position (upper band break) or a long position (lower band break) with the upper, middle, or lower band as your target exit. You must use other technical indicators or chart patterns with this reversal strategy.
2. The Squeeze Strategy – This strategy is the most widely used. Volatility is what ultimately drives Bollinger Bands. There is no better way of reflecting volatility than by gauging the initiation of a squeeze. In short, you will be on the lookout for sudden band expansion. Upon market consolidation, bands will restrict and form what is referred to as a horizontal channel, and when this happens, the price action will go back and forth within a narrow range. Low volatility in the market will cause the bands to be narrow and will ultimately end in a Bollinger Band breakout.
Bollinger Bands is a technical analysis tool invented by John Bollinger in the 1980s as well as a term trademarked by him in 2011. Having evolved from the concept of trading bands, Bollinger Bands and the related indicators %b and bandwidth can be used to measure the "highness" or "lowness" of the price relative to previous trades. Bollinger Bands are a volatility indicator similar to the Keltner channel.
Bollinger Bands consist of:
- an N-period moving average (MA)
- an upper band at K times an N-period standard deviation above the moving average (MA + Kσ)
- a lower band at K times an N-period standard deviation below the moving average (MA − Kσ)
Typical values for N and K are 20 and 2, respectively. The default choice for the average is a simple moving average, but other types of averages can be employed as needed. Exponential moving averages is a common second choice. Usually the same period is used for both the middle band and the calculation of standard deviation.