The Bollinger Bands indicator is one of those indicators that work well as a trend indicator and as a non-trending indicator. The bands were developed by John Bollinger. They consist of 3 lines. The middle line of the band is a simple moving average that is commonly set at a period of 20. The outer bands are commonly set at 2 standard deviations from the simple moving average line. This means that about 95.4% of the time, the price will stay contained within the outer bands.
The Bollinger Bands can be used in a number of ways. They will show volatility based on price movement. When there is greater volatility, the bands will widen. When the bands narrow, they are showing less volatility. As prices consolidate, the bands narrow and can warn of an impending breakout.
When prices are trending, the bands will tend to act as a channel with the middle band acting as a support or resistance. In an upward trend, prices will tend to stay in the upper half of the band with the middle band acting as support. In a downward trend, prices will tend to stay in the lower half of the band with the middle band acting as resistance.
Since the Bollinger Bands typical settings contain 95.4% of the movement, the bands can indicate when a price is overbought or oversold. This occurs when the price breaks through the outer bands. We use the Bollinger Bands as a key indicator for the bounce trade.
In the bounce trade, we want to make sure there is volatility represented by wider bands. We want to use the bands as an additional indication of an overbought or oversold condition (to go along with the CCI and Stochastic indicators.) Finally, we use the moving average (the middle line) of the band as our target exit point.
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