Bollinger bands

These indicators are derived from moving averages and aim at filling in an important gap. Indeed, moving averages give buying and selling signals at punctual levels, which can thus quickly be invalidated should the market reverse on the very short term (during the session or from a session to another).

It can thus be wise, rather than defining precise thresholds, to use zones defined as intervals on both sides of the moving average. Bollinger bands are built on this very principle. This figure is composed of three trend lines: the middle, upper and lower bands.

The middle band corresponds to a simple moving average, often calculated on 20 days.

The level of the upper band, in every point, corresponds to the sum of the level of the middle band and twice the value of the standard deviation associated to the moving average.

Reciprocally, the level of the lower band corresponds to the level of the middle band diminished by twice the value of the standard deviation associated to the moving average.

An envelop of the stock price is thus determined. This makes it possible to then identify the variation margin in which the stock should stay almost systematically. In the case of a stock following a Gauss law, 95 % of the trades will thus occur between these bands.

These latter then constitute very strong support (lower band) and resistance (upper band) levels. These levels respectively represent interesting buying and selling levels, particularly when no real trend appears on the market (and bands are thus stable on both sides of the average), which enables to play with a trading target (short term target).

In opposition, in a trend market, clues given by bands are related to their spread. Indeed, a growing spread of bands means a growing standard deviation, which is the sign of the beginning a strong trend. Then, when bands narrow, variations on both sides of the moving average get smaller, which suggests the end of a trend. It is then possible to use bands as supports and resistances.