The Bollinger Band Width is the difference between the upper and the lower Bollinger Bands divided by the middle band. Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you're most comfortable with.
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When the price moves up, the bands spread apart. The upper and lower bands measure volatility or the degree in the variation of prices over time. Because Bollinger Bands measure volatility, the bands adjust automatically to changing market conditions. The middle line of the indicator is a simple moving average SMA. Most charting programs default to a period, which is fine for most traders, but you can experiment with different moving average lengths after you get a little experience applying Bollinger Bands.
The upper and lower bands, by default, represent two standard deviations above and below the middle line moving average.
You can try out different standard deviations for the bands once you become more familiar with how they work. One thing you should know about Bollinger Bands is that the price tends to return to the middle of the bands. If you said down, then you are correct! The information they provide should be used in conjunction with other forms of analysis. Bollinger bands can be useful indicators of a trend in a market — strong trends cause volatility, which is easy to see as the Bollinger bands widen and narrow.
When plotted automatically by a trading platform, Bollinger bands are very user-friendly and can add another dimension to chart analysis for a trader. This means that traders might not receive signals until the price movement is already underway. It is also worth noting that John Bollinger — the man who invented Bollinger bands — has said that they should be used in conjunction with other forms of technical analysis and that they are not fool-proof or fail-safe indicators of market trends.
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IG International Limited is licensed to conduct investment business and digital asset business by the Bermuda Monetary Authority. For a given data set, the standard deviation measures how spread out numbers are from an average value. Standard deviation can be calculated by taking the square root of the variance, which itself is the average of the squared differences of the mean. Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA.
Those produce the upper and lower bands. Many traders believe the closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. John Bollinger has a set of 22 rules to follow when using the bands as a trading system. Because standard deviation is a measure of volatility, when the markets become more volatile the bands widen; during less volatile periods, the bands contract.
When the bands come close together, constricting the moving average, it is called a squeeze. A squeeze signals a period of low volatility and is considered by traders to be a potential sign of future increased volatility and possible trading opportunities. Conversely, the wider apart the bands move, the more likely the chance of a decrease in volatility and the greater the possibility of exiting a trade.
However, these conditions are not trading signals. The bands give no indication when the change may take place or which direction price could move. Any breakout above or below the bands is a major event. The breakout is not a trading signal. The mistake most people make is believing that that price hitting or exceeding one of the bands is a signal to buy or sell. Breakouts provide no clue as to the direction and extent of future price movement.
They are simply one indicator designed to provide traders with information regarding price volatility. John Bollinger suggests using them with two or three other non-correlated indicators that provide more direct market signals. He believes it is crucial to use indicators based on different types of data.
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