Bollinger Bands: reading volatility around the price

Construction

Developed by John Bollinger in the 1980s, the bands consist of a 20-period simple moving average, plus an upper and a lower band placed two standard deviations away.

Middle band = SMA(20)
Upper band = SMA(20) + 2 × standard deviation(20)
Lower band = SMA(20) − 2 × standard deviation(20)

Because the standard deviation measures dispersion, the width of the bands is a direct reading of volatility.

The squeeze

When the bands contract to their narrowest in months, volatility is unusually low. Periods of calm tend to be followed by periods of movement, so a squeeze often precedes a larger move — but it says nothing about its direction.

Touching a band is not a signal

A close above the upper band means the price is far from its average relative to recent volatility. In a strong trend, the price can “walk” along a band for many sessions. As John Bollinger himself stresses, a touch of the band is information, not a buy or sell signal.

The %B indicator expresses where the price sits within the bands: 1 at the upper band, 0 at the lower band, 0.5 on the average.

Bollinger and Keltner

Keltner channels draw a similar envelope but use the Average True Range (ATR) instead of the standard deviation. When the Bollinger Bands contract inside the Keltner channels, many analysts consider volatility to be particularly compressed.

Bollinger Bands in InvestAI

InvestAI calculates Bollinger Bands, Keltner and Donchian channels, ATR and historical volatility. They are grouped in the “Mean reversion” preset with the RSI, the Stochastic and Williams %R. Each indicator reports its reading and the reason for it.