The Bollinger Bands (BB) is a widely used tool for technical analysis in financial markets which was created by financial analyst and trader John Bollinger in the early 1980s. It is an oscillator measurer which indicates volatility in the market and overbought/oversold conditions. It is composed of an upper band, a lower band, and a middle moving average line in the middle, and the upper and lower bands react to the market price action, expanding and contracting according to volatility.
The standard Bollinger Bands formula sets the middle line as a 20-day simple moving average (SMA), with the upper and lower bands two standard deviations (x2) away from the middle line. This is done to ensure that at least 85% of the price data will be within the two bands.
The indicator can be used in multiple ways, but should ideally be used in conjunction with other technical analysis indicators to give a better idea of market conditions. For example, if the price exceeds the upper Bollinger band, it suggests that the market is overextended (overbought condition), and if it drops significantly and exceeds/touches the lower band multiple times, this may indicate an oversold market or a strong support level. Traders may also use it to predict high or low volatility moments.
The Keltner Channels (KC) indicator is another good option, based on the Average True Range (ATR) rather than SMA and standard deviations. The KC indicator tends to be tighter than Bollinger Bands, making it more effective at spotting trend reversals and overbought/oversold conditions. Conversely, Bollinger Bands represent market volatility better, since the expansion/contraction movements are more obvious.
The two can also be used together, providing better and more reliable signals. In general, the Bollinger Bands is the more popular tool, but both can be useful for short-term trading strategies.
