Introduced by John Bollinger in the 1980s, Bollinger bands (BB) is perhaps one of
the most useful indicators used in technical analysis. BB are used to determine
overbought and oversold levels, where a trader will try to sell when the price
reaches the top of the band and will execute a buy when the price reaches the
bottom of the band.
The BB has 3 components:
1. Middle line which is The 20 day simple moving average of the closing prices
2. An upper band – this is the +2 standard deviation of the middle line
3. A lower band – this is the -2 standard deviation of the middle line
The standard deviation (SD) is a statistical concept; which measures the variance of
a particular variable from its average. In finance, the standard deviation of the stock
price represents the volatility of a stock. For example, if the standard deviation of a
stock is 12%, it is as good as saying that the volatility of the stock is 12%.
In BB, the standard deviation is applied on the 20 day SMA. The upper band
indicates the +2 SD. By using a +2 SD, we simply multiply the SD by 2, and add it to
For example if the 20 day SMA is 7800, and the SD is 75 (or 0.96%), then the +2 SD
would be 7800 + (75*2) = 7950. Likewise, a -2 SD indicates we multiply the SD by 2,
and subtract it from the average. 7800 – (2*75) = 7650.
We now have the components of the BB:
1. 20 day SMA = 7800
2. Upper band = 7950
3. Lower band = 7650
Statistically speaking, the current market price should hover around the average
price of 7800. However, if the current market price is around 7950, then it is
considered expensive with respect to the average, hence one should look at
shorting opportunities with an expectation that the price will scale back to its
Therefore the trade would be to sell at 7950, with a target of 7800.
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