Bollinger Bands were introduced by John Bollinger, a technical analyst.
It is a combination of fundamental and technical analysis called as relative analysis.
Bollinger Bands consists of a 20-day simple moving average of close prices and a 2-Standard deviation of 20-day simple moving average as upper and lower bands.
These three lines move as a dynamic channel acting as dynamic support and resistance.
Middle Band = 20-day simple moving average (SMA)
Upper Band = 20-day SMA + (2 * 20-day standard deviation of price)
Lower Band = 20-day SMA – (2 * 20-day standard deviation of price)
According to normal distribution, values lie within 1-standard deviation 68% of the time and within 2-standard deviation 95% of the time.
When there is volatility in the price movement, these bands widen from each other. And, conversely when there is less volatility in price movement, these bands contract and move towards each other.
How to interpret Bollinger Bands:
- They provided good support and resistance when market/price movement of stock is in sideways.
- When the price breaks upper band and stays for a period of time, it is considered as bullish.
- When the price breaks lower band and stays for a period of time, it is considered as bearish.
- As with any other indicator, Bollinger Bands alone will not provide buying/selling signal. They must be used in conjunction with other indicator.