Bollinger Bands

From Forexpedia

Bollinger Bands are a simple technical analysis tool developed by John Bollinger, and are used to measure the volatility of a market as well as to indicate relative price levels.

Bollinger Bands consist of three lines. The center line is calculated by taking a simple moving average of the price of an asset. Traders most commonly use a 20 or 21-day moving average when calculating the center line of a Bollinger Band. Once the center line is calculated, the upper and lower bands are drawn two standard deviations above or below the moving average. The standard deviation of a market price varies depending on the difference between high and low prices for a given trading day, which means that when an asset becomes more volatile, the Bollinger Band expands, whereas when an asset becomes less volatile, the Bollinger Band contracts. This gives traders an idea of an asset's volatility.

If prices fall outside of two standard deviations of the median price (meaning that, on a candlestick chart, they fall outside of the Bollinger Band), those prices have reached an extremely high or extremely low level for the asset at that time. This can be a signal that a breakout from the trend is imminent, or a warning that an asset is overbought or oversold. When such indicators occur during a period of low volatility, this can be a very strong indicator of a coming reversal in trend, giving traders a signal to take the appropriate action with respect to that asset.