Section: 3 Market Structure
Sub Section: 3 Bollinger Bands (BB)
Bollinger Bands are indicators
that are plotted at standard deviation levels above and below a simple moving
average. Since standard deviation is a measure of volatility, a large standard
deviation indicates a volatile market, while a smaller standard deviation
indicates a calmer market. Bollinger Bands are a good way to compare volatility
and relative price levels over a period of time.
Even though Bollinger Bands can help generate buy and sell signals, they are not designed to determine the future direction of a security. Buy and sell signals are not given when prices reach the upper or lower bands. Such levels merely indicate that prices are high or low on a relative basis. A security can become overbought or oversold for an extended period of time. Knowing whether or not prices are high or low on a relative basis can enhance our interpretation of other indicators and assist with timing issues in trading.
An example is illustrated graphically as follows: