Bollinger Bands

Bollinger Bands offer two primary trading strategies:

Mean reversion (band touches): When price touches or pierces the lower band, the stock is statistically oversold (2 standard deviations below the mean). Combined with RSI below 30, this creates a high-probability bounce setup. Buy at the lower band, target the middle band (20 SMA), and set a stop just below the band touch. The opposite applies for upper band touches — sell or short when price reaches the upper band in a range-bound market.

Breakout trading (Bollinger squeeze): When the bands contract to their narrowest width in weeks, volatility is extremely low and a big move is imminent. This is called the "Bollinger squeeze." The direction of the breakout is unknown, but the magnitude tends to be large. Trade the squeeze by waiting for price to close outside the bands on above-average volume, then enter in the breakout direction with a stop inside the squeeze range.

Important caveat: In strong trends, price can "walk the band" — staying at or near the upper (or lower) band for extended periods. Selling every upper band touch during a strong uptrend is a losing strategy. Always confirm Bollinger Band signals with trend context and other indicators like RSI or MACD.

The default Bollinger Band settings are a 20-period simple moving average with bands at 2 standard deviations. Here is how the math works:

Middle band: 20-period SMA = sum of the last 20 closing prices divided by 20.

Upper band: Middle band + (2 x standard deviation of the last 20 closes).

Lower band: Middle band - (2 x standard deviation of the last 20 closes).

Why 2 standard deviations? In a normal distribution, 95.4% of data falls within 2 standard deviations of the mean. This means price should stay inside the bands roughly 95% of the time — making excursions outside the bands statistically significant events worth trading.

Alternative settings: Day traders often use shorter periods (9 or 10) with 1.5 standard deviations for faster signals on 5-minute charts. Swing traders may use 50-period bands for a broader view. Some traders use exponential moving averages (EMA) instead of SMA for the middle band, which gives more weight to recent prices.

Bandwidth indicator: Bollinger Bandwidth measures the distance between the bands as a percentage of the middle band. Low bandwidth values (historically tight bands) signal upcoming breakouts. Many charting platforms display bandwidth as a separate indicator below the price chart, making squeezes easier to spot.

%B indicator: %B shows where the current price falls relative to the bands. %B = (Price - Lower Band) / (Upper Band - Lower Band). A %B of 0 means price is at the lower band; 1.0 means price is at the upper band; 0.5 means price is at the middle band. Values above 1.0 or below 0 indicate price has broken outside the bands.

Mistake 1: Trading band touches without trend context. In a strong uptrend, price will repeatedly touch or exceed the upper band. Shorting every upper band touch in a trending market is a reliable way to lose money. Always assess the broader trend (using the 50-day or 200-day moving average) before treating a band touch as a reversal signal. Band touches are mean-reversion signals that work in range-bound markets, not trending ones.

Mistake 2: Assuming the squeeze predicts direction. A Bollinger squeeze tells you a big move is coming — it does not tell you which direction. Traders who take a position during the squeeze (before the breakout) are guessing. Wait for the close outside the bands with volume confirmation before committing.

Mistake 3: Using Bollinger Bands in isolation. Bollinger Bands measure volatility and price extremes, but they say nothing about momentum, volume, or fundamental context. The highest-probability setups combine Bollinger Bands with a second indicator: RSI for momentum confirmation, volume for participation confirmation, or VWAP for intraday trend direction.

Mistake 4: Ignoring the middle band. Most traders focus on the outer bands, but the 20 SMA (middle band) is a powerful support/resistance level on its own. In a healthy uptrend, pullbacks to the middle band often produce bounces. A close below the middle band in an uptrend can be an early warning that the trend is weakening.

Mistake 5: Wrong timeframe for your strategy. Default 20-period Bollinger Bands on a daily chart are designed for swing trading (holding days to weeks). If you are day trading on 5-minute charts, the 20-period setting measures just 100 minutes of data — too short for reliable signals. Adjust the period length to match your trading timeframe.