Bollinger bands are an indicator which is primarily intended to show you or warn you of an impending thrust in the underlying's prices. It does not give reliable indications about the direction of those price moves or thrusts nearly as often. Use of the bands can help you time your purchases when you are forewarned a thrust is expected shortly.
Bollinger bands are displayed on your chart as a 3 line envelope of prices. They have at their center for the middle line a normal moving average. This moving average is adjustable just as with any normal moving average. You can adjust how many days you wish to use and also how you wish the
average to be computed; simple, exponential or any other choice you may desire.
This is one of those places where knowing the cycle lengths comes in handy. You might want to find and use a prevalent cycle time period for the construction of the moving average in your bands. Set up the middle line or band, the moving average in the manner you wish and when the calculation is
completed and drawn on your chart you will have also displayed an upper and a lower band which is a standard deviation to compute them. This standard deviation component is another variable which you would set up in your initial construction of the bands. You can use one or more standard
deviations.
By using a standard deviation in the computation of the bands you get a measure of the volatility of the underlying security. These bands will constrict during times of low volatility and will widen when volatility increases.
Four of the indications or interpretations you will get when using Bollinger Bands is the following. #1 - It has been noted that when volatility of an underlying security is weak and the bands are constricted and narrow, there tends to be a break out or a period of sharp price changes and a resulting increase in volatility. The longer the bands constrict and prices remain within narrow bands the more likely a break out becomes. Note that this does not tell you which direction the increase in
volatility and sharp price changes will occur. Only that it is likely to happen in either direction.
#2 When security prices begin a move from one the the two outer bands, the price move of the security tends to continue until it reaches the other band. This is something to look for and use that is pretty straight forward and simple but is not as reliable as # 1 above.
#3 Another tendency of prices when they exceed one of the outer bands is that the trend in that direction will continue. It is a confirmation that this trend is in place and will likely continue for a longer period of time.
#4 When bottoms or tops occur outside the bands, which is then followed by another bottom or top within the bands is a trend reversal indication.
Using Bollinger Bands, as well as technical analysis in general, is much more an art than a science. Bollinger Bands do not provide much in the way of buy and sell point indications but if you have other indicators blaring buy or sell signals while the Bollinger bands are constricted, you have additional evidence to help you with the decision about a trade.
You should study Bollinger Bands and all the variables in the initial set up phase. Pick a stock you routinely analyze and adjust one of the components of the Bolliger bands and see what difference is displayed. Go back to the construction phase and change another variable and look at the same data
on your chart again. Study how to interpret the bands and it's likely they will improve your decision making and trading.