Bollinger Bands are volatility bands placed above and below a moving average (middle band). The middle band is a simple moving average (default 20 periods) of the average candle price ((High+Low+Close)/3). The upper and lower bands are ‘X’ standard deviations (generally X = 2) above and below the middle band. The bands widen and narrow when the volatility of the price is higher or lower, respectively.
Trading with Bollinger Bands: Bollinger Bands are an indicator of overbought or oversold conditions. When the price is near the upper or lower band it indicates that a reversal may be imminent. The middle band becomes a support or resistance level. The upper and lower bands can also be interpreted as price targets. When the price bounces off of the lower band and crosses the middle band, then the upper band becomes the price target.
Below conditions can be used to take positions in a ranging market. These are just indicative and can be twisted as per once trading style.
Entry Long:
Middle Band Crosses below Close
Or Lower Band Crosses below Close
Exit Long:
Middle Band Crosses Above Close (This would act as a stop loss)
Or Upper Band Crosses Above High
Entry Short:
Middle Band Crosses above Close
Or Upper Band Crosses above Close
Exit Short:
Middle Band Crosses below Close (This would act as a stop loss)
Or Lower Band Crosses above Close
The above style may not work in a trending market.
In a trending market, the middle band can be used as an entry point when there is a pullback. Breakout in a lower band or upper band can be used as trend reversal in case of uptrend or downtrend respectively.
Bollinger Band width:
It is the difference between the Upper Band and Lower Band and is a measure of volatility. The Band Width value is higher when volatility is high, and lower when volatility is low. It can be used to screen stocks with high and low volatility.
Bollinger Band Width % = (Upper Band – Lower Band)/Middle Band * 100
Or (2 * X (default = 2) * standard deviation)/Moving Average * 100