Bollinger Bands and reading volatility

Bollinger Bands measure volatility. They are not a reversal-finding tool, and misreading that is why
so many people lose money with them.

1. What they are made of

• The middle band — a moving average,
  usually a 20-period SMA.
• The upper and lower bands — two standard deviations of price either side of the
  middle.

Because standard deviation moves with market volatility, the outer bands widen
automatically when the market is active and contract when it is quiet. That is the whole value
of the indicator.

2. The biggest mistake

Price touching the upper band does not mean overbought and due to fall. In a strong
uptrend, price can ride the upper band for session after session.

Statistically, about 95% of observations fall within two standard deviations — but the remaining 5%
are precisely the strongest moves, which is exactly when you do not want to be standing in front of
them.

3. Three uses that are worth something

The squeeze

When the bands contract very tightly, volatility is unusually low. That state often precedes a large
move — but it says nothing about direction. The way to use it: prepare for a
breakout and trade the direction it breaks, rather than
predicting it.

Riding the band

Price repeatedly touching the upper band while the middle band acts as support is a sign of a healthy
trend. That is a with-trend signal — the exact opposite of how the indicator is usually
used.

The middle band as a dynamic zone

Within a trend, price often pulls back to the middle band and then continues. An entry there has a
far better risk-reward ratio than an entry at the outer
band.

4. What to pair it with

Bollinger Bands describe the volatility state but not direction. They need a directional tool
alongside — price structure, a long-term moving average, or
analysis on a higher timeframe.

A common combination: establish direction on H4, then use Bollinger on H1 to find an entry as price
pulls back to the middle band.

5. Settings

The default is a 20 period and 2 standard deviations. Some traders use 2.5 to reduce false signals on
volatile instruments such as gold. That is a reasonable adjustment, but change it once and leave it —
continually retuning settings to fit the most recent data is over-optimisation.

6. One more practical application

Band width is a useful volatility measure for setting stop distance. When the bands
are wide the market is active and the stop needs to be proportionally wider — with a smaller position
size to keep the money risk the same.

This article is for information only and is not investment advice. Conditions and fee levels are published by the brokers and can change at any time — check with the broker you actually use. Leveraged forex and CFD trading carries a high level of risk and can cost you your entire deposit.