Bollinger Bands® is an indicator that measures market volatility. Bollinger Bands® was invented by the technical analyst John Bollinger in the 1980s, and he obtained trademark protection for the indicator in 2011.
Bollinger Bands® consists of three lines: A middle line and an upper and lower line, often encapsulating the price chart. The middle line is an exponential moving average, indicating whether the price is trading above or below the average for the period. The two outer lines represent the market’s volatility by using what is called the Standard Deviation. Standard Deviation – or spread – is used within probability theory and expresses how much a stochastic variable distributes itself around its mean.
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In trading, the standard deviation is calculated based on the average price over a period. This is done by squaring the distance from the mean to each data point (for example, the closing price), then adding these together and dividing by the number of data points to find the average of the variance. The standard deviation is the square root of the variance.
As a trader, you can use Bollinger Bands® to assess the trend of a stock. The outer bands change such that they spread apart when there is high volatility in the market, whereas they come closer together when there is low volatility. If the price breaks above the upper band, one can expect that a strong uptrend is underway. Conversely, if the price breaks below the lower band, one can expect that a strong downtrend is in progress. Bollinger Bands® are similar to the slightly less known Keltner Channels, but these use the so-called Average True Range to draw the outer bands.
You can activate Bollinger Bands® at the trading platform Markets by clicking “Indicators” and then “Bollinger Bands”.
