The Bollinger Bands, or BB, were developed in the 1980s by financial analyst and trader John Bollinger. Since then, many traders and chartists have been using the BB as a technical analysis (TA) indicator.
In essence, the Bollinger Bands function as a measurement tool of market oscillations. As such, the BB indicator can be used to identify the moments that a particular market presents high or low volatility. Also, they can be useful for spotting potential overbought or oversold market conditions.
The BB indicator consists of two sidelong bands and a middle line. These three elements indicate how prices more around an average value, which is represented by the middle band. The upper and lower bands expand when market volatility is high, and contract when market volatility is low. They either move away from the middle band (high volatility) or towards it (low volatility).
The Bollinger Bands are among the most used TA indicators, especially in traditional financial markets. However, they are also used by cryptocurrency traders. Still, BB should not be used as a stand-alone tool but rather in conjunction with other TA tools and indicators, to decrease the overall risks.
There are a few basic ways of reading and interpreting the information provided by the BB indicator.
For instance, imagine that the price of an asset moves from below the middle line all the way up to the upper band, surpassing it. This would indicate a potential overbought condition. The same reading logic applies to the opposite side. If an asset’s price exceeds the lower band, it may be indicative of oversold conditions. The upper and lower bands may also suggest potential support and resistance levels, in which the price is likely to bounce.
Other than that, the movement of the upper and lower bands in relation to the middle line is a very important factor of the BB indicator. The expansion and contraction of the bands may come handy when traders and chartists are trying to predict the next periods of market volatility (or lack thereof).
For example, if the volatility starts increasing, the bands will expand and move away from the middle line. In contrast, if the market volatility decreases, the bands will contract and move towards the middle.
For a more in-depth explanation of Bollinger Bands, see our article: Bollinger Bands Explained