Bollinger Bands

The Structure

John Bollinger developed Bollinger Bands in the 1980s. They consist of three lines:

• Middle Band: 20-period Simple Moving Average
• Upper Band: 20 SMA + 2 standard deviations
• Lower Band: 20 SMA − 2 standard deviations

Because standard deviation measures how spread out the data is, the bands automatically widen when price is volatile and narrow when price is quiet. They're self-adjusting to market conditions.

The 95% Rule (In Theory)

With 2-standard-deviation bands, statistics textbooks say about 95% of price action should fall inside the bands. Real markets are not normally distributed, though: John Bollinger's own empirical estimate is that roughly 88-90% of price action stays inside the bands in practice. The practical point is the same either way: when price does touch the outer band, something meaningful is happening. It's not an extreme move, but it's a statistically notable one.

The Bollinger Band Squeeze

This is one of the most powerful signals in technical analysis. When the upper and lower bands move very close together, it means volatility has compressed dramatically. Low volatility periods are typically followed by high volatility periods: the market is "coiling."

The Squeeze tells you a big move is coming. It does NOT tell you which direction. For direction, you need additional signals: a breakout candle, a trend in the higher timeframe, a catalyst event (earnings, NFP, central bank decision).

Walking the Band

In a strong uptrend, price can "walk" the upper Bollinger Band for an extended period, touching or exceeding it candle after candle. Beginners mistake this for an extreme and sell. Experienced traders recognize it as a sign of exceptional momentum and either hold or add to long positions.

The same logic applies in downtrends: walking the lower band signals strong bearish momentum, not an immediate buy opportunity.

Mean Reversion with Bollinger Bands

In ranging, oscillating markets, Bollinger Bands are excellent for mean-reversion trading:

1. Price touches the lower band.
2. A bullish reversal candle forms (pin bar, bullish engulfing).
3. Enter long, targeting the middle band (20 SMA) or upper band.

This works well in choppy conditions but fails in trends: in a downtrend, touching the lower band is just the continuation of the trend, not a reversal opportunity.

Practical Settings

The standard settings (20, 2) are used by the vast majority of traders. Some adjust to (20, 2.5) for fewer signals at extreme prices. The period and deviation can be changed, but departure from the standard reduces how reliably other traders will react to the same levels.