Bollinger Bands were created by John A. Bollinger. They compare volatility and relative price levels over a period time. The indicator consists of three bands designed to encompass the majority of a security's price action: a Moving Average in the middle, an upper band (MA plus x -standard deviations) and a lower band (MA minus x standard deviations).
Since the bands encompass normal price behavior, it is possible to identify abnormal price levels; the bands squeeze together when volatility is low and spread apart when volatility is high.
The use of Bollinger Bands varies widely among traders. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band. Moreover, the use of Bollinger Bands is not confined to stock traders; options traders, most notably implied volatility traders, often sell options when Bollinger Bands are historically far apart or buy options when the Bollinger Bands are historically close together, in both instances, expecting volatility to revert towards the average historical volatility level for the stock.
When the bands lie close together, a period of low volatility is indicated. Conversely, as the bands expand, an increase in price action/market volatility is indicated. When the bands have only a slight slope and track approximately parallel for an extended time, the price will generally be found to oscillate between the bands as though in a channel.
Traders are often inclined to use Bollinger Bands with other indicators to confirm price action. In particular, the use of oscillator-like Bollinger Bands will often be coupled with a non-oscillator indicator-like chart patterns or a trendline. If these indicators confirm the recommendation of the Bollinger Bands, the trader will have greater conviction that the bands are predicting correct price action in relation to market volatility.
Read more about John Bollinger's indicators.
Bollinger Bands are the registered trademark of John Bollinger, who developed them.