What are Bollinger Bands, and how to read them

A Bollinger Band consists of a simple moving average (a middle band), and a lower and an upper band. These bands show standard deviations (positive and negative) from a simple moving average. The lower band is set below a moving average, and the upper band is set above the moving average.

The width of the band indicates the volatility. If the band is narrow, the volatility is low, and on the contrary, if the band is wide, the volatility is high.

Traders use Bollinger Bands to see whether the market is overbought or oversold. If the asset price moves close to the upper band, the market is overbought. If the asset price moves to the lower band, the market is oversold. 

The Bounce

97% of all price changes occur within the Bollinger bands. And the price tends to return to the middle band. This is the idea behind the Bounce.

So, if the price reaches the top of the band, it is more likely to start moving downward and settle somewhere close to the middle band.

The reason why it occurs is that the lower and upper bands act like support and resistance levels. 

This principle works when the price moves in the range determined by the Bollinger bands when there is NO trend in the market. When the market is trending, other patterns are used.

The Squeeze

When the bands come very close to each other, it is called a squeeze. It means that the volatility is very low, and soon, you can expect a breakout. If the price breaks out above the upper band, it normally continues going up (the market is trending). 

And on the contrary, if the price breaks out below the lower band, the market is in a downtrend, and the price will most likely continue to fall. 

Bottom Line

There are many more patterns you can use, but these two are the main ones, while the others are built based on them. Don’t forget that Bollinger Bands are price indicators, so combine them with other indicators (e.g., volume indicators) to make wiser trading decisions.