Bollinger Bands are a channel of moving averages over stock prices. Bollinger Bands consist of three lines:
- center line
- upper line
- lower line
The upper line moves above the stock price. The lower line moves below the stock price. The center line moves between the two lines.
The above chart shows the Bollinger Bands for General Motors’ (GM) stock.
Calculating Bollinger Bands
Center line = 20-day simple moving average (or SMA)
Upper line = 20-day SMA + (20-day standard deviation of price multiplied by two)
It’s important to note that standard deviation is a measure of volatility.
Lower line = 20-day SMA – (20-day standard deviation of price multiplied by two)
Bollinger Bands are combination of a stock’s moving averages. When a stock’s volatility increases, the moving average channel expands. When volatility decreases, the channel tightens. The expanding and tightening indicate a trend change.
When the stock’s price falls to the lower channel of the Bollinger Band and trades at the support level, it could be used as an entry point. When the stock’s price reaches the upper channel of the Bollinger Band and trades near the resistance level, it could be used as an exit point.
When the stock’s price trades near the upper or lower channel of the Bollinger Bands, this indicates that the stock is overbought and oversold. Bollinger Bands shouldn’t be used as a single indicator for determining the trade. Bollinger Bands, combined with other indicators and patterns, are useful for entry and exit points.