Bollinger Bands Lesson - MenthorQ Academy

Bollinger Bands are one of the most widely used technical analysis indicators, created by John Bollinger in the 1980s. This lesson walks you through the structure of Bollinger Bands, how they measure price volatility, and multiple practical strategies for incorporating them into your trading decisions.

Bollinger Bands consist of three key elements: a middle band (typically a 20-day simple moving average), an upper band, and a lower band. The outer bands are positioned two standard deviations away from the middle band, which statistically means that 95% of price action develops within these bands. You can adjust both the standard deviation and moving average parameters in the indicator settings to suit your trading style.

The bands dynamically respond to market conditions. When bands are narrow or close together, volatility is low, often indicating a period of consolidation. Conversely, when bands are wide or expanding, volatility is high, potentially signaling the start of a new price trend. The Bollinger band squeeze strategy focuses on these contraction periods as “the calm before the storm”—historically, low volatility periods often precede significant price movements or breakouts.

You can use Bollinger Bands to identify efficient entry points by trading in the direction of the trend. During an uptrend, the lower band can serve as an entry signal during pullbacks, while in a downtrend, the upper band acts as confirmation for potential short positions. A common mistake traders make is going short when price leaves the upper band or going long when it leaves the lower band, expecting reversals—but as demonstrated with examples on Amazon and Johnson and Johnson stocks, the bands work best when aligned with the existing trend direction.

Bollinger Bands also function as trailing stops or take profit targets. During an uptrend, if price crosses the lower band downward, it can signal an exit point. In horizontal or range-bound markets, the bands provide confirmation of support and resistance levels, working effectively with channel trading strategies. However, the indicator has limitations during volatile periods, as breaks aren’t always followed by continuation moves, so you should use Bollinger Bands in conjunction with other indicators to support your overall strategy.

Video Chapters

00:00 – Introduction to Bollinger Bands and their structure
00:57 – Understanding band width and volatility measurement
01:49 – Using Bollinger Bands to ride the trend and find entry points
02:47 – The Bollinger band squeeze strategy
04:31 – Using bands as trailing stops and take profit targets
05:36 – Trading with Bollinger Bands in horizontal trending markets

Key Takeaways

Bollinger Bands consist of a 20-day moving average with bands set two standard deviations away, capturing 95% of price action
Narrow bands signal low volatility and potential upcoming breakouts, while wide bands indicate high volatility and active trends
Trade in the direction of the trend using the lower band for uptrends and upper band for downtrends as entry confirmation
Bollinger Bands work best when combined with other indicators, as they are not always reliable during volatile periods

Video Transcription

[00:00:00.05] - Speaker 1
Bollinger bands are one of the most used technical analysis indicators. They were created by John Bollinger in the 1980s. This tool is designed to give traders a clearer picture of price volatility and market trends. They represent a price volatility indicator. Bollinger bands are made up of three elements.

[00:00:20.17] - Speaker 1
The middle band, which is a simple moving average, typically a 20 day moving average, and two outer bands, the upper band and the lower band. These bands are set two standard deviations away from the middle band, one above and one below. The Bollinger bands standard deviation and moving average can be adjusted in the indicator settings. As you can see here in statistics, the two standard deviations are used to represent that 95% of the price action develops within these bands. Looking back, 95% of prices were recorded within the two bands.

[00:00:57.11] - Speaker 1
The upper and lower Bollinger bands thus measure the dispersion of the price around the moving average and the volatility. Another element to consider is the structure of the bands. The closer or narrower the bands are to each other, the lower the price volatility will be. For technical analysts, the contraction of the bands represents a period of consolidation. The further the bands are from each other, the greater the price volatility.

[00:01:24.21] - Speaker 1
Expanding bands can often indicate the start of the new price trend. Since they are based on volatility, the bands widen and narrow based on market volatility. Now let's look at some examples of how to use Bollinger bands in trading. The first example is to use the Bollinger bands to ride the trend and find efficient entry points. A basic rule is to trade in the direction of the trend.

[00:01:49.11] - Speaker 1
Let's look at this example of some mistakes traders make when using Bollinger bands. The strategy that many use is to go short when the price leaves the upper bands and go long when the price leaves the lower bands. Many think that because the price has gone out of the bands, there will be a trend reversal. As you can see, this is not the case. Instead, using them in the direction of the trend can help us find efficient entry points.

[00:02:14.25] - Speaker 1
In the case of an uptrend, we can use the lower band to locate entry points as in this case. As we can see prices record increasing highs and lows, we are in trend and want to look for an efficient entry point during a pullback. In this case, we use the touch of the lower band and the proximity to the trend line as a signal. We can do the same in a downtrend where we use the upper band. In this example, the price retraces towards the trend line and we can use the Bollinger band as a confirmation signal for a potential short.

[00:02:47.25] - Speaker 1
One of the most used strategies by traders is the one called Bollinger band squeeze. As you can see from the chart, after a trend period we see a sharp drop in volatility and a price consolidation. The market is currently taking a breather. We are seeing a balance between buyers and sellers. When the bands contract and come close together, it indicates a period of low volatility in the market.

[00:03:13.01] - Speaker 1
This low volatility is like the calm before the storm. Historically, these periods of low volatility often precede significant price movements. It's as if the market is holding its breath before making a big move. The Bollinger bands provide us with a warning signal. In this case, the the price may show a breakout move or an explosive move in the future.

[00:03:36.29] - Speaker 1
This makes narrow bands a signal for traders to be on alert for potential breakouts or significant trend changes. On the other hand, wide Bollinger bands tell a different story. They indicate that the market is experiencing high volatility. When the bands expand, it shows that there's a strong movement in price either upward or downward. This high volatility can be due to various factors like economic announcements, geopolitical events or significant market news.

[00:04:07.15] - Speaker 1
For traders, wide bands mean that the market is in motion and there's potential for significant gains or losses. Another way to use Bollinger bands is to find optimal entry points. When the market is in a trend phase, we are not always able to capture the perfect entry point. We talked about trend lines and support and resistance. Another way is through the Bollinger bands.

[00:04:31.01] - Speaker 1
The bands consist of an upper and lower band and an intermediate line representing the 20 period moving average. We can use Bollinger bands to locate entry points like in this example. In this case we use the lower band as an entry level during an uptrend. Bollinger bands can then be used as a trailing stop or or take profit targets. If we are in a trade during a trend period, we can use the lower band as a trailing stop in case of an uptrend.

[00:05:00.05] - Speaker 1
When the price crosses this band downwards, we can decide to exit the trade like in this example. Another common application of Bollinger bands by traders is to identify potential entry points during times when the market is exhibiting a horizontal trend or oscillating between support and resistance levels. Lets look at some examples. The first example is through the conjunction of this indicator with a support and resistance analysis. In this case on the Amazon stock, we see two areas of support and resistance outlined by the green and red line.

[00:05:36.09] - Speaker 1
The lower Bollinger band provides confirmation of support by offering two entry points. The upper Bollinger band instead acts as a resistance level. Another example is through the use of Bollinger bands for trading across channels in horizontal trending periods, as in this case on Johnson and Johnson, we can see entry confirmations and support or resistance offered by the Bollinger bands when the price touches the lower line of the channel. In this case, the lower band acts as a support when the price touches the upper channel line. We see how the upper Bollinger band acts as resistance.

[00:06:15.25] - Speaker 1
A problem with this indicator is that it is not very resilient in periods of volatility, and breaks are not always followed by continuations of the movement. Bollinger bands should be used to support your strategy decision in conjunction with other indicators.