What is a Bollinger Band?
Bollinger Bands are a type of technical analysis tool in finance that is used to measure volatility and provide a relative definition of high and low prices. The tool was invented by John Bollinger in the early 1980s and is named after him. The Bollinger Bands consist of three lines that are plotted on a chart: a simple moving average in the middle and two standard deviation lines, one above and one below the moving average. The distance between the bands varies based on the volatility of the underlying asset being analyzed.
The basic idea behind Bollinger Bands is that prices tend to remain within the upper and lower bands during normal market conditions and break out of the bands during periods of increased volatility. If prices are consistently close to the upper band, it may indicate that the asset is overbought and may be due for a price correction. Conversely, if prices are consistently close to the lower band, it may indicate that the asset is oversold and may be due for a price increase.
Traders and investors use Bollinger Bands as a tool to make informed trading decisions by looking at the relationship between price and the bands. For example, they may buy a stock when the price touches the lower band, or sell a stock when the price touches the upper band. It's important to note that Bollinger Bands are not a standalone trading strategy, but rather a tool to be used in conjunction with other technical and fundamental analysis methods.
Popular Examples of Bollinger Band
Moving Average Envelope: A Moving Average Envelope is a technical analysis indicator that uses a moving average to create upper and lower bands that are placed a set percentage above and below the moving average line. The width of the bands can be adjusted to be more or less sensitive to price changes.
Keltner Channel: The Keltner Channel is a technical analysis indicator that uses an exponential moving average and the Average True Range (ATR) to create upper and lower bands that are a set distance away from the moving average line. The Keltner Channel is used to help identify potential breakouts and reversals.
Donchian Channel: The Donchian Channel is a technical analysis indicator that uses the highest high and lowest low over a set period of time to create upper and lower bands. The width of the bands can be adjusted based on the user's preferences. The Donchian Channel is used to identify potential breakouts and trend reversals.
The Bollinger Band can be compared to the elastic band that is used to wrap around packages. The band is flexible and can stretch or shrink based on the volatility of the financial asset it represents. When the price of the asset is stable and not fluctuating much, the band will be narrow. But when the price is volatile and moving quickly, the band will stretch and become wider. The Bollinger Band is a tool used in technical analysis to determine whether a financial asset is overbought or oversold, and it provides an indication of future price movements. Just like the elastic band helps to secure the package, the Bollinger Band helps traders to secure their investments by providing a visual representation of market volatility.