Bollinger Bands show the trading range of a market instrument. They consist of an upper line and a lower line; these indicate the likely top and bottom of the price range. There is also a middle line, which is the moving average of the price.
Bollinger Bands are similar to Envelopes:
- Envelopes are plotted a fixed percentage distance away from the moving price average
- Bollinger Bands are plotted a number of standard deviations away from the average
Since standard deviation measures market volatility, Bollinger Bands move apart when the market is volatile, and come together when the market is stable.
Bollinger Bands are interpreted in the following ways:
- Prices tend to remain between the top and bottom bands
- Abrupt price changes often happen after the bands contract
- A trend continuation is likely if the price breaks through the upper band
- A trend reversal may occur if pikes and hollows form outside the bands and then form inside the bands
- A price movement that starts at one band usually reaches the other band – this is useful for forecasting price movements
The middle line is usually the simple moving average of the closing price.
ML = SMA( CLOSE, N )
N is the number of intervals used for the average
N = 2 is recommended – a value of less than 10 is ineffective
The top line is placed a number of standard deviations above the middle line.
TL = ML + ( D * StdDev )
D is the number of standard deviations – 2 is recommended
The bottom line is placed a number of standard deviations below the middle line.
TL = ML – ( D * StdDev )
You can find more information about technical indicators in the MetaTrader 4 User Guide. Select Help > Help Topics > Analytics > Technical Indicators.