Bollinger Bands are lines plotted in and around the price structure to form an “envelope.” It is the action of prices near the edges of the envelope. Bollinger Bands are based upon a simple moving average. This is because a simple moving average is used in the standard deviation calculation . John Bollinger developed the technique of using moving averages with two trading bands.
A simple moving average in the middle
- An upper band (SMA plus 2 standard deviations. Close price or the average of High, Low and Close are usually used to calculate the SMA. Standard Deviation is a statistical term that provides a good indication of volatility. Using the standard deviation ensures that the bands will react quickly to price movements and reflect periods of high and low volatility.)
- A lower band (SMA minus 2 standard deviations)
To identify periods of high and low volatility
- To identify periods when prices are at extreme, and possibly unsustainable, levels.
- To arrive at rigorous buy and sell decisions.