Bollinger Bands: A Technical Analysis Tool for Identifying Overbought and Oversold Conditions
Bollinger Bands are a technical analysis tool that can be used to identify overbought and oversold conditions in a security's price. They were created by John Bollinger in the 1980s and are still widely used by traders today.
Bollinger Bands are made up of three lines: a moving average, an upper band, and a lower band. The moving average is the middle line and is calculated by taking the average price of the security over a certain period of time, such as 20 days. The upper band is calculated by adding a certain number of standard deviations to the moving average, and the lower band is calculated by subtracting a certain number of standard deviations from the moving average.
The number of standard deviations used to calculate the upper and lower bands is a user-defined input. The most common setting is 2 standard deviations, but traders may choose to use a different setting depending on their trading style and risk tolerance.
Bollinger Bands can be used to identify overbought and oversold conditions by looking at the relationship between the security's price and the bands. When the security's price is trading above the upper band, it is considered to be overbought. When the security's price is trading below the lower band, it is considered to be oversold.
Overbought and oversold conditions can be used to identify potential trading opportunities. For example, a trader may decide to sell a security that is trading above the upper band or buy a security that is trading below the lower band.
It is important to note that Bollinger Bands are only a technical analysis tool and should not be used as the sole basis for making trading decisions. Traders should also consider other factors, such as the security's fundamentals, before making a trade.