Bollinger bands are a technical analysis indicator with a set of lines plotted two standard deviations above and below the simple moving average (SMA). The band can be changed by adjusting the SMA settings to a different timeframe, the most common setting is the 20 day SMA setting. However, it is important to note that Bollinger Bands should not serve as a sole indicator when undergoing technical analysis.
How to use the Bollinger Band
Many traders believe the closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. The concept is that the price action will always oscillate around the 20 day SMA line to reestablish equilibrium. Because standard deviation is a measure of volatility, when the markets become more volatile the bands widen; during less volatile periods, the bands contract.
When the bands come close together, constricting the moving average, it is called a squeeze. A squeeze signals a period of low volatility and is considered by traders to be a potential sign of future increased volatility. Volatility provides traders opportunity to enter trades due to an increased amount of price action.