Bollinger Bands are an important technical analysis tool. This tip explainsthe term and its relevance to you as an investor.
What is it?
Generally, trading bands are lines drawn at fixed distance around a moving average. The Bollinger Band concept is that a stock usually trades within a predictable range on either side of the moving average. Bollinger Bands vary in distance from the moving average based on volatility. The upper band is the standard deviation above the moving average, and the lower band is the standard deviation below the moving average.
Bollinger Bands are insightful tools helpful for spotting trends. These are valuable indicators of when the markets are overbought or oversold. While technical analysis is not fool proof, it assists the investor to make informed market choices. Sharp moves tend to occur after the bands tighten to the average. A move outside the bands calls for a continuation of the trend. Tops and bottoms formed outside the bands, followed by tops and bottoms formed inside the bands, indicate a trend reversal. A move originating at one band tends to go to the other band.