The Bollinger bands can be termed as a variation of Moving Average Envelopes but unlike the MA version, the Bollinger Bands are not placed at any fixed percentage away from the price. These Volatility bands are placed a fixed Standard Deviation away from a fixed Moving Average of the price. The inventor John Bollinger expressed his preference for a 20 day Moving Average and Standard Deviation of 2. The BB undergoes a cycle of expansion and contraction. A contraction of the BB implies a collapse of the volatility and an impending expansion in the form of a trending move.
Advantages And Limitations of Bollinger Band
The major advantage of the BB comes from reading the volatility and using Bandwidth, showing the difference between the two bands inside a fixed range, can give excellent signals for the possibility of a major move. Another big strategy is “Walking the Band” or following the trend as long as the move touched the band in that direction. A strong uptrend will keep testing the upper band all the way to the top and the reverse may be expected in a strong downtrend. The failure to test the upper/lower band can give the initial warning for a probable top/bottom.