The Bollinger Bands is considered a trend indicator that uses trading bands similar to envelopes. There are two bands on either side of a moving average. The outer bands add and subtract a standard deviation calculation that measures the volatility of price and ensures that 80% of the price remains within the bands.
As volatility increases the bands expand, as it decreases the bands contract. The basic premise of Bollinger Bands is that price should remain within 2 standard deviations (outer bands) of the mean which is the center line moving average. The center line is a 20 period moving average and acts as the trend indicator. When the market is above the MA it is trending long and when it is below the moving average it is trending down.
Bollinger Bands are used to measure volatility and give traders an indication of how high or low prices are relative to the recent past. They are also used to identify overbought or oversold conditions in the market represented by the two outer bands. A touch of the upper band represents overbought and a touch of the lower band represents oversold.
There are two main methods of trading with Bollinger bands, namely the Bollinger bounce and the Bollinger squeeze.
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