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 widen when volatility increases and narrow when volatility decreases.
Bollinger Bands consist of a middle band and two outer bands. The middle band is a simple moving average and is usually set at 20 periods. The outer bands are typically set 2 standard deviations above and below the middle band. That’s why the label on the chart reads “BB(20,2,0)”.
Bollinger Bands reflect (a) direction with the 20-period simple moving average and (b) volatility with the upper/lower bands. Statistically, the bands should contain roughly 90% of price action, which makes a move outside the bands significant. Technically, prices are relatively high when above the upper band and relatively low when below the lower band. However, these bands should not be used as a stand-alone tool, since prices can be relatively high or low for a reason. Bollinger Bands should be combined with other indicators to confirm bullish or bearish signals.
Walking the Bands
Moves above or below the bands are not necessarily buy or sell signals. At face value, a move to the upper band shows strength, while a drop below the lower band shows weakness. Prices can “walk the band” with a number of touches during a strong uptrend. Consider this: the upper band is 2 standard deviations above the 20-period simple moving average. So it takes a strong price movement to exceed this upper band, which is likely preceded by a strong fundamental driver. So it is imprudent to take the indicator as a stand-alone tool to buy or sell a security.