How to Bollinger Bands Work?

Bollinger Bands are made up of three lines. The first line (middle line) is a 20 day standard moving average line. Two other lines are plotted, an upper bound which represents a 2 standard deviation move above the moving average line and a lower bound that represents a two standard deviation move below the moving average.

Bollinger bands can be used for any time period data (from tick data to monthly). They are designed to react quickly to changes in momentum. When prices move above their upper bound they are higher relative to the average. Conversely, when prices move below the lower bound they are low relative to their average.

Whilst the 20 day period is standard, Bollinger suggest for shorter time periods or trends that a 10 period moving average is appropriate. For longer trends a 50 day moving average can be incorporated.

Our FX Trading platform there is a simple tool that enables you to draw bollinger bands and the output is shown below

How to trade Bollinger Bands

Bollinger bands are not generally used as a trading system by themselves. Usually, they are used in conjunction with other technical analysis indicators as confirmation of a pattern or signal. For example, if a price reaches the upper band during a breakout pattern (such as a head and shoulders bottom) then this might help confirm a new uptrend. However, if prices hit the upper Bollinger Band with no accompanying signals then this might be a short sell opportunity.

Some empirical studies have noted that good results have been obtained by buying when the price reaches the lower bound and closing when the price touches the upper bound.

Published on 5th of May 2011
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