Bollinger Bands are technical analysis indicators used in stock trading, developed by John Bollinger in the 1980s. They involve calculating moving averages and standard deviation to create upper and lower bands, which traders use to determine trading signals.
Bollinger Bands are indicators used when trading stocks using a technical analysis approach. Technical analysis is an approach to investing in the market that attempts to use a disciplined approach to market timing. Bollinger Bands were developed by John Bollinger in the 1980s.
Technical analysis approaches involve calculating moving averages of the stocks in interest. A moving average is simply an average that is calculated over a period of time and repeated as time passes. A typical moving average is the seven-day moving average, calculated by adding the share price over the last seven trading days and dividing the result by seven. One day later, the average is calculated again, but the price of day one falls and the price of day two becomes the price of day one. This is repeated each day until the original price of day seven is replaced. This process is repeated each trading day and the results can be plotted as the average price of the shares against time.
Using the same data set from which the average is calculated, a standard deviation series can be calculated for the same data set. Two more lines are drawn on the graph, the first showing the average plus one standard deviation and the second showing the average minus one standard deviation. These two lines are called Bollinger bands. The average plus one standard deviation is the upper Bollinger band and the average 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 approach the upper Bollinger bands, the stock is believed to be in its high price range. If stocks are nearing lower Bollinger bands, then they are said to be in their lower trading range. If the stock price were to break outside of any of the Bollinger Bands, then a significant movement in the stock price is expected. John Bollinger, who came up with the concept of Bollinger Bands, is now a financial commentator for CNBC and maintains a website with much more information on his Bollinger Band theories and concepts.
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