Bollinger Bans were developed by John Bollinger. They are a set of bands that are plotted at 2 standard deviations above and below an exponential moving average (20-day is widely used) and are displayed over a stock's price chart. Using 2 standard deviations guarantees 95% of the price data will lay between the bands.
Since the bands are plotted at standard deviation levels, they are self-adjusting. When a stock becomes more volatile, the bands widen to give the stock more “room to move” within the bands. When a stock meanders around with little day-to-day movement, the bands contract.
Because of the tendency for a stock to stay within the bands, prices are considered overbought when they reach the upper band and oversold when they reach the lower band.
Bollinger offers the following characteristics:
Expect sharp prices changes after volatility lessens and the bands narrow.
When a stock moves outside the bands, expect the trend to continue.
A reversal usually occurs after a bottom or top is made outside the bands and then the underlying issue moves back inside the bands.
Prices tend to move from one band to the other, so this can aid in projecting price targets.