Bollinger Bands® are volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes as volatility increases and decreases. The bands automatically widen when volatility increases and narrow when volatility decreases.
Calculation
Middle Band = 20-day simple moving average (SMA)
Upper Band = 20-day SMA + (20-day standard deviation of price x 2)
Lower Band = 20-day SMA – (20-day standard deviation of price x 2)
Bollinger Bands consist of a middle band with two outer bands. The middle band is a simple moving average that is usually set at 20 periods. A simple moving average is used because the standard deviation formula also uses a simple moving average. The look-back period for the standard deviation is the same as for the simple moving average. The outer bands are usually set 2 standard deviations above and below the middle band.
This is one of the most popular technical analysis techniques. The closer the prices move to the upper band, the more overbought the market is, and the closer the prices move to the lower band, the more oversold the market is.
