Bollinger Band

Bollinger Band consists of one center line and two outer band.

Center line = simple  20-day Simple Moving Average (SMA).(Further info of moving average line)

Upper band = 20-day SMA + 20-day Standard Deviation of price x2

Lower band = 20-day SMA - 20-day Standard Deviation of price x2

What is Standard Deviation?

Standard Deviation is a measurement of volatility of price. High standard deviation means high volatility. For example, a stock with price 10 has 20-day standard deviation of 1 means in the past 20 days, stock price always moves in the range of plus/minus 1.

Uses of Bollinger Band

Continuous outer band touching

Since Outer Band is built based on  20-day SMA plus/minus 20-day Standard Deviation of price x2, it needs high momentum in order for the price to touch the outer band. A few days for price continuously touching upper band indicate a sudden increase of buy power and usually is a sign of uptrend.

Out of the outer band

It needs a lot of momentum for price to go out of the band, and usually such a high momentum will not last long. So when you see the price  go out of the outer band a lot, it indicates a retract in a short time.

Riding the outer band

When a strong trend is formed, the price will be very close to the outer band continuously. For example, when up trend is strong, price will only move between center line and  upper band. Center line serves as a good supporting line for the price.

Change side

When price sudden change from one outer band to another outer band pass through center line, for example from upper band to lower band, it means something had happened suddenly. which cause the price to move through 4 standard deviation. If it happened gradually, it means a mid term correction or even the reversal of the trend.

Outer band Contract

The width of outer band is depend on the standard deviation which means volatility of stock price in the past 20 days. If the outer band contract to a narrow space(especially with the decrease of volume), it means a break out will occur soon (either up or down). The theory behind this conditions is when the institution investors collecting/ disposing stock, the price usually remain constant causing the volatility to decrease. When the outer band contract to a certain narrow space with decreasing in volume, its means institution investors almost finish collecting/disposing stock, they will start to pull up/ bring down the stock price. 

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