Bollinger Bands® are composed of three bands and help measure a security's volatility. The first band is a Simple Moving Average, which shows the average of a security's price over a fixed period of time. The second and third bands reflect two standard deviations - a statistical measure of volatility - in either direction from the average. Because Bollinger Bands® use standard deviation, major changes in price will cause the bands to either contract or spread out. The further apart the outer bands, the greater the volatility.
In addition to measuring volatility, Bollinger Bands® also help analysts make investment predictions. When a security's price range approaches the upper band, it may mean that the security is overbought and will begin to lose value. Similarly, when the price moves toward the lower band, it could signify that the security is oversold and its price may soon begin to rise.
Bollinger Bands® are displayed as three bands. The middle band is a normal moving average. In the following formula, 'n' is the number of time periods in the moving average (e.g., 20 days).
The upper band is the same as the middle band, but shifted up by the number of standard deviations (e.g., two deviations). In this next formula, 'D' is the number of standard deviations.
The lower band is the moving average shifted down by the same number of standard deviations (i.e., 'D').
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.