Bollinger Bands are overlay channels that are drawn using a stock’s Moving Average (MA) and the standard deviation from the Moving Average. They consist of three bands:
A middle band (typically plotted using a stock’s 20-day moving average)
A lower band (typically plotted one or two standard deviations below the moving average)
An upper band (typically plotted one or two standard deviations above the moving average)
The lower (upper) bands can be used to represent levels of support (resistance). It could be a sign that the stock is overbought (oversold) when the price approaches resistance (support) levels. During a ranging market, some traders sell a stock when the price meets resistance around the upper band. Alternatively, they may buy when the price approaches the lower band.
Traders can also use Bollinger Bands to gauge the volatility of a price trend. The upper and lower bands are looser (tighter) when the trend is more (less) volatile. A key principle of the Bollinger Bands is that periods of high volatility precede periods of low volatility and vice versa. Accordingly, traders can use Bollinger Bands to time their trades. A period known as The Squeeze occurs when the bands are narrow and trading volume is low. The Squeeze periofd is generally considered a sign that price volatility is about to increase and a trading opportunity could present itself. Conversely, when the Bands are far apart, it could be a sign that price volatility is about to decrease and it might be a good time to exit a position.
Parameters
Standard Deviation - How many standard deviations the upper (and lower) bands should be plotted above (and below) the moving average.
Type - Which type of moving average to use for the middle band? Simple, Exponential, or otherwise.
Field - Which price field to use to calculate the average (eg. Close Price)
Period - How many periods (eg. days) to lookback when calculating the moving average (ie. the middle band)