Bollinger Bands is a technical analysis tool invented by John Bollinger in 1980. It is primarily used to analyze market volatility, and trend strength, and can also act as an indicator for overbought or oversold conditions.
Bollinger Bands consist of three lines: the middle line is typically the 20-day moving average, while the upper and lower bands represent the standard deviations of the middle line.
When the asset price approaches the upper band, it may indicate an overbought condition; when it approaches the lower band, it may indicate an oversold condition.
Bollinger Band Width and Bollinger %B are derived from the Bollinger Bands.
Bollinger Band Width is used to measure the width of the Bollinger Bands, expressed as a numerical value that reflects market volatility. When the Bollinger Band width is large, it indicates higher market volatility; when the width is small, it indicates lower volatility.
Bollinger %B is used to measure the position of an asset’s price relative to the Bollinger Bands, reflecting the overbought or oversold condition of the market.
As the asset price approaches the upper band, the Bollinger %B approaches 1, indicating a potential overbought condition. Conversely, as the asset price approaches the lower band, the Bollinger %B approaches 0, indicating a potential oversold condition.
📈 HowLifeUSA uses TradingView charts to create its illustrations. Unless otherwise noted, all chart images are created using TradingView.
Table of Contents
How to Calculate and Plot Bollinger Bands?
Bollinger Bands consist of three main lines: the Middle Band, the Upper Band, and the Lower Band.
Middle Band
The middle band is usually a moving average over a certain period (e.g., 20 days). It is calculated by taking the closing prices of the last 20 days and averaging them.
The formula is as follows:
where n is the selected period (e.g., 20 days).
Upper and Lower Bands
The upper and lower bands are derived by calculating the standard deviation of the n-day prices. The bands are placed two standard deviations away from the middle band.
The upper band is formulated as below:
Similarly, the formula for the lower band is as follows:
Plotting Bollinger Bands
By calculating the values of the Middle Band, Upper Band, and Lower Band, you can plot the Bollinger Bands on the chart.
These bands are typically displayed along with the price line, providing visual insights into market volatility.
Bollinger Band Width
Bollinger Band Width indicates the relative width between the bands and reflects changes in market volatility.
When the bandwidth increases, it suggests that market volatility is rising.
When the bandwidth decreases, it suggests that market volatility is decreasing.
The formula for Bollinger bandwidth is as:
Bollinger %B
Bollinger %B measures how far the current price is from the upper and lower bands, providing insights into overbought or oversold conditions. It helps identify potential buy or sell points.
The value of %B ranges from 0 to 1, with more than 1 indicating overbought and less than 0 indicating oversold.
The formula for its calculation is as follows:
Displaying Bollinger Band Width and %B:
Bollinger Band Width (BWB) and Bollinger %B are typically displayed in separate charts below the price line, providing further context to the market conditions.
How to Use Bollinger Bands, Bollinger Bandwidth, and Bollinger %B
Bollinger Bands consist of an upper boundary, a lower boundary, and a middle line. These bands are typically plotted on charts along with price lines.
Here are some common uses of Bollinger Bands, Bollinger Band Width, and Bollinger %B:
Determining Price Trends
When the bandwidth of the Bollinger Bands widens, it indicates an increase in market volatility and typically signals the beginning of a trend.
When the bandwidth of the Bollinger Bands narrows, it indicates a decrease in market volatility and often signals that the trend is weakening or that the market is entering a consolidation phase.
Determining Overbought or Oversold Conditions
Bollinger Bands can be used alongside other overbought and oversold indicators (e.g., RSI, CCI) for more comprehensive analysis.
When the price approaches or touches the lower band of the Bollinger Bands, and the RSI shows that the market is oversold, this is often interpreted as a signal of an oversold market, suggesting a potential price reversal.
However, if the RSI does not indicate an oversold condition, the price approaching the lower band might just indicate that the market still has room to move downward.
What are the limitations of using Bollinger Bands?
While Bollinger Bands are a popular technical analysis tool that can help you identify market volatility, trend strength, and overbought or oversold conditions, they do have some limitations, particularly when used in isolation.
Bollinger Bands rely heavily on historical price data to calculate current price ranges. They indicate where prices are relative to the upper and lower bands, but they cannot accurately predict the direction or magnitude of future price movements.
In other words, Bollinger Bands can only provide a snapshot of current market volatility and cannot predict how the market will evolve.
Therefore, relying solely on Bollinger Bands to make trading decisions can lead to misjudgments, especially during periods of sharp price volatility.
Additionally, because Bollinger Bands are calculated using moving averages and standard deviations—both based on past price data—they are inherently lagging indicators.
This means they do not react instantly to rapid market changes. In fast-moving markets, Bollinger Bands may fail to capture sharp price movements in a timely manner, leading to delayed trading signals.
In sideways or consolidating markets without a clear trend, Bollinger Bands may produce misleading signals. Since the upper and lower bands frequently come into contact with prices in such markets, they might cause traders to enter and exit positions too frequently, increasing both trading costs and risk.
In these conditions, Bollinger Bands signals may not be reliable, and “false breakouts” or “false pullbacks” could occur, resulting in unnecessary losses.
To mitigate these limitations, the most effective approach is to use Bollinger Bands in combination with other technical indicators, such as the Relative Strength Index (RSI), MACD, and support/resistance levels.
By combining multiple indicators, you can get a more comprehensive view of market conditions and reduce the likelihood of misleading signals that can occur when Bollinger Bands are used alone.
For instance, while Bollinger Bands may indicate that the price is approaching the upper band, if the RSI has not yet reached overbought territory, the price may still continue to rise. Thus, combining Bollinger Bands with other technical analysis tools can help you make more accurate and informed trading decisions.
More Ariticals abut Technical Anlysis
- What are Bollinger Bands and how do I use them?
- What is Moving Average (MA)?
- What is the Money Flow Index (MFI)? And How to use it?
Disclaimer
NON-INVESTMENT ADVICE: The content provided here is for informational purposes only and does not constitute professional, investment, or financial advice. Always seek professional guidance tailored to your situation.
Risk of Loss: Trading securities and derivatives involves inherent risks, including the loss of principal. Past performance is not indicative of future results.
NON-VALUATION: This material is not an official valuation of any of the securities or derivatives mentioned herein. Any pricing information provided is for informational purposes only and does not reflect the level at which TradeUP is prepared to execute trades; nor is it intended to demonstrate the actual results that may be realized from any trade.
🚀 Investing Tools
Interactive Brokers Moomoo Firstrade Robinhood Tradingview