Bollinger Bands
Bollinger Bands, created by John Bollinger, are line plots above and below a moving average, with the spacing between the lines dependent on price volatility. The upper line is two standard deviations above, and the lower line is two standard deviations below, the moving average. Thus, the bands are wider when volatility is high and they get narrower when volatility is low.
When price goes up to the higher band, it indicates an overbought condition, but this does not necessarily indicate a reversal because the overbought condition can last for quite a while.
When price falls to the lower band, it indicates an oversold condition, but this does not necessarily indicate a reversal because the oversold condition can last for quite a while.
A trend that hugs one band signals that the trend is strong and likely to continue. Wait for divergence where the MACD is going in the opposite direction of the price - then the price will often break out in the direction of the MACD.
In a ranging market, a move that starts at one band normally carries through to the other band.
Prices tend to stay within the bounds of the upper and lower band, but when prices move outside the bands in the direction of the current trend, it indicates continuation of the trend.
When the bands narrow, it increases the probability of a breakout. Contracting bands warn that the market is about to trend: the bands first converge into a narrow neck, followed by a sharp price movement. It is dangerous to have a position when the bands narrow, because it is uncertain whether it is going to breakout up or down. It may be better to close out old positions until a clear direction is evident. Although the Bollinger Bands don't indicate which direction the breakout will be, the Chaos Oscillator (MACD) and Momentum can do that. The price will usually break out in the direction the Momentum and Chaos (MACD) are going.
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