Bollinger Bands
Bollinger Bands Explained
Bollinger Bands, created by John Bollinger, are a versatile volatility indicator that consists of three lines plotted on a stock's price chart. They help you understand whether a stock's price is relatively high or low compared to its recent trading range.
The Three Bands
- Middle Band — A 20-day Simple Moving Average (SMA) of the closing price.
- Upper Band — The middle band plus 2 standard deviations. This represents a price level that is statistically "high."
- Lower Band — The middle band minus 2 standard deviations. This represents a price level that is statistically "low."
Approximately 95% of price action occurs within the bands, based on the statistical properties of standard deviation.
Key Bollinger Band Signals
- The Squeeze — When the bands contract and narrow, volatility is low. This often precedes a significant price move (breakout) in either direction. It is a "calm before the storm" signal.
- Expansion — When the bands widen rapidly, a strong trend or high-volatility move is underway.
- Price touching the upper band — The stock may be overbought in the short term. This does not necessarily mean you should sell, especially in a strong uptrend where prices can "ride" the upper band.
- Price touching the lower band — The stock may be oversold. Again, in a strong downtrend, prices can ride the lower band.
Bollinger Bands on NSE Stocks
Imagine Safaricom (SCOM) has been trading in a narrow range for several weeks, and the Bollinger Bands have squeezed tightly together. This tells you that a breakout is likely coming. If SCOM then breaks above the upper band on strong volume, it is often the start of a new upward move. Conversely, a break below the lower band on heavy volume could signal further downside.
Common Mistakes with Bollinger Bands
The most common mistake is treating band touches as automatic buy or sell signals. Price touching the upper band does not mean "sell immediately" — in a strong uptrend, it simply confirms the bullish momentum. Always use Bollinger Bands in combination with other indicators like RSI or volume for confirmation.