Bollinger Bands are technical indicators used in stock trading. They involve calculating moving averages and standard deviations to create upper and lower bands on a chart. Traders use these bands to determine trading signals and predict significant changes in stock prices. John Bollinger created the concept and is now a financial commentator with CNBC.
Bollinger Bands are indicators used when trading stocks using a technical analysis approach. Technical analysis is an approach to market investing that attempts to use a disciplined market timing approach. Bollinger Bands were developed by John Bollinger in the 1980s.
Technical analysis approaches involve calculating the moving averages of the security in interest. A moving average is simply an average calculated over a period of time and repeated over time. A typical moving average is the seven-day moving average, calculated by adding the stock price over the last seven trading days and dividing the result by seven. The next day, the average is calculated again, but the first day’s price is lowered and the second day’s price becomes the first day’s price. This is repeated every day until the original seventh day price is replaced. This process is repeated every trading day and the results can be plotted as an average share price over time.
Using the same dataset from which the mean is calculated, a series of standard deviations can be calculated for the same dataset. Two more lines are drawn on the graph, the first showing the mean plus one standard deviation and the second showing the mean minus one standard deviation. These two lines are called Bollinger Bands. The mean plus one standard deviation is the upper Bollinger Band and the mean minus one standard deviation is the lower Bollinger Band. There are now four lines on the chart: the daily stock price, the moving average, and the upper and lower Bollinger Bands.
Technical traders use this information to determine trading signals. If stock prices are nearing the upper Bollinger Bands, the stock is thought to be in its high price range. If stocks approach the lower Bollinger Bands, they are said to be in their lower trading range. If the stock price were to break outside of one of the Bollinger Bands, a significant change in the stock price is expected. John Bollinger, who invented the concept of Bollinger Bands, is now a financial commentator with CNBC and maintains a site on the Internet with much more information on his theories and concepts regarding Bollinger Bands.
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