bollinger bands are a technical
indicator that can help you define
trends
and measure the volatility of securities
like stocks in this video
we'll explain how bollinger bands are
calculated and applied
and address the benefits and risks of
using this indicator
the bands are calculated using standard
deviation from a moving average
standard deviation is a statistic used
in probability theory and is commonly
applied in financial markets to measure
volatility
in financial markets standard deviation
measures the volatility of returns from
a historical average
or mean such as a 20-day moving average
bollinger bands are typically plotted
two standard deviations above and below
a moving average
this means about 95 percent of the
securities historical price movement
is likely contained within the two bands
this information can help you add
context to trends
and potentially determine when they
might be overextended and reverse
because the bands typically contain
about 95 percent of a security's price
movement
it's unusual but possible for the price
to move outside the bands
but when it does probability theory
assumes the security price is likely to
revert back to a moving average
or mean between the upper and lower
bands
this is called mean reversion and some
investors might use it to make trading
decisions
let's look at an example of how you may
be able to identify entry and exit
points using bollinger bands
a potential entry point can be set up
when the price of a security
falls below the lower band here an
investor might wait for the price to
close back above the band before
entering the trade
this is a form of confirmation when
applying mean reversion strategies
a reversion to the mean is complete when
the security rises back to its moving
average
some investors use this as an exit point
others might target the upper band as an
exit point
which is typically a bigger profit
target and can take longer to achieve
investors using the upper band as a
target might look for confirmation by
letting the price move above the upper
band
and then waiting for a close back below
the band before exiting a trade
the idea is that a break back below the
upper band is likely to revert to the
moving average
some investors look for additional
confirmation by considering the slope of
the bands
but in simple terms if the bands are
sloping up
then the security is in a potential
uptrend conversely if the bands are
sloping down
then the security is in a potential
downtrend so by referring to the slope
some investors might only take entry
points and uptrends and ignore entry
points and downtrends
timing entry and exit points in these
ways is one of the main benefits of
applying bollinger bands
additionally the bands can help
investors visualize statistical
properties of securities
and help identify when prices move
unexpectedly to standard deviations away
from a moving average
keep in mind that these deviations can
last for long periods of time
which is one of the biggest risks of
using bollinger bands
remember that probability theory assumes
that security prices are mean reverting
but this assumption frequently breaks
down in the real world
here's a typical example of a security
that has fallen to its lower band
or two standard deviations away from its
moving average
notice how the price continues falling
along its lower band
before eventually returning to the
moving average
a mean reversion can take a long time
and during that time
the price of a security can continue
falling that's why investors typically
avoid taking entry points
every time a security falls below the
lower band
using bollinger bands as a standalone
indicator is risky
for a more balanced approach an investor
might consider using bollinger bands to
add context to trends
and help time entry and exit points that
arise from other forms of analysis
such as fundamentals and the market's
overall trend
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