Bollinger Bands were invented by John Bollinger and a re a staple technical analysts tool when charting the markets. Bollinger bands provide an upper bound and lower bound based on a simple moving average. A bollinger band is basically indicating the volatility of a asset and whether it is moving outside of its expected price ranges and breaking trend and shows where the strong support and resistance levels are.
What are Bollinger Bands?
A bollinger band is the standard deviation of price movements in a set period. The period is defined in the bollinger band itself so a bollinger band 10 is based on ten periods and a bollinger band 20 is based on 20 periods. The more volatile the period the larger the bollinger band is around the the price as the the larger the potential price movements are.
The more quiet a trading period that the bollinger band is based on then the bands themselves contract around the price and become narrower. Sometimes traders use the narrowing to indicate a consolidation period before an increase in volatility - this is useful for knowing when to buy options based on particular strategies such as vol straddles.
How do Bollinger Bands Work?
A bollinger band is calculated by getting the standard deviation for a particular period. For example if there is a bollinger band 20 it will have taken the previous 20 trading periods and calculated their standard deviation based on the 20 day SMA. Two standard deviations are then added to the SMA to create the upper band and 2 standard deviations are subtracted from the SMA to create the bottom band, This is supposed to show that 95% of price moves should lie. If the price moves outside of these bounds then an exceptional price move is going on. Bollinger bands are often used in conjunction with other technical analysis indicators.
Example Chart Bollinger Bands and Analysis
If you look at the chart above of the ETH-BTC price you can see two bollinger bands overlayed on the chart - the BB 20 and the BB 5. The BB 5 is much more reactive to recent price swings and shows a smaller band level around the price in comparison to the BB20. Conversely tbe BB 20 show wide bands and lag after a price move more as they take into account a longer set of volatility.
The first blue marker shows the ethereum price moving against both the BB5 and 20 upper limit and the BB5 corssing the BB20 - both indicators of trend reversal or a shift in momentum. The second red marker shows the opposite.