The Stock Stethoscope

Bollinger Bands (BB) is a technical analysis tool that is used to measure volatility in financial markets. It consists of three lines that are plotted on a price chart, with the middle line being a simple moving average (SMA) and the other two lines being standard deviations away from the middle line.

The standard deviation is a statistical measure that indicates how much the price of an asset is deviating from its average price. In the case of Bollinger Bands, the upper band is plotted two standard deviations away from the SMA, and the lower band is plotted two standard deviations below the SMA.

The formula for Bollinger Bands is as follows:

Middle Band = n-period Simple Moving Average (SMA)
Upper Band = Middle Band + (k x n-period Standard Deviation)
Lower Band = Middle Band – (k x n-period Standard Deviation)

Where:

n is the number of periods used for the SMA
k is the number of standard deviations used for the upper and lower bands
For example, if we use a 20-period SMA and set k to 2, the Bollinger Bands will be plotted as follows:

Middle Band: 20-period SMA
Upper Band: 20-period SMA + (2 x 20-period standard deviation)
Lower Band: 20-period SMA – (2 x 20-period standard deviation)
The best settings for the Bollinger Bands depend on the time frame of the chart being analyzed and the market being traded. A commonly used setting is a 20-period SMA with a standard deviation of 2, but some traders may use different settings based on their trading style and preferences.

The Bollinger Bands are often used in conjunction with other technical indicators to confirm signals or identify potential trading opportunities. For example, traders may look for a price breakout above or below the bands, which could indicate a trend reversal or continuation. They may also look for divergence between the price and the bands, which could indicate a change in momentum.

Additionally, traders may use other technical indicators such as the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) to confirm signals generated by the Bollinger Bands.

To sum up, Bollinger Bands are a widely used technical analysis tool that measures volatility in financial markets. The best settings for the indicator depend on the time frame of the chart being analyzed and the market being traded, and it is often used in conjunction with other technical indicators to confirm signals or identify potential trading opportunities.