Bollinger Bands
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.
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