Bollinger Bands Definition: Day Trading Terminology
Bollinger Bands is a technical indicator that was developed by famous technical trader John Bollinger and is used to measure volatility based on standard deviations. Bollinger Bands consist of a middle band, which is a 21-day simple moving average, that is bracketed by an upper and lower volatility band to signify overbought/sold conditions when prices reach these outer bands.
The bands are calculated using a standard deviation model which adjusts for market volatility and is usually set at two standard deviations above and below the middle moving average. These settings can be adjusted based on your own personal trading style.
The outer bands will contract and expand based on price volatility. In the chart above you will notice that when price action is volatile the outer bands expand until prices cool off and then they will begin to tighten up again.
The tighter the bands get the more likely prices will pick up in volatility and the wider they get the more likely they will begin to contract. Prices rarely goes outside the bands but when they do it usually doesn’t last too long as prices will look to retrace to the middle band to correct the extreme conditions.
Bollinger Bands have become one of the most popular technical indicators out there as both new and veteran traders look to utilize its benefits for trading in almost every market.
Warrior Trading Pro Tip – Bollinger Band Trading Strategy
There a lot of different ways to use the Bollinger Bands to your benefit but one of our favorite ways to use them are for reversals. We like to see at least 5 candles close outside the the outer bands, whether it be on the upper band or the lower band. This shows prices are getting very overbought/sold and are likely to pullback to the center moving average (orange line).
The entry would be when you get a candle to cross below the lows of the previous and hold till first profit target is met at the moving average. Stop order would be at highs or lows of that move. As with any technical indicator, it works best in conjunction with other indicators like the RSI or stochastic.