Bollinger Bands are a popular technical analysis tool used to measure a stock's volatility and identify potential overbought or oversold conditions. They consist of three lines that wrap around a stock's price:
The three parts of Bollinger Bands:
• The middle band is a simple moving average (usually 20 days).
• The upper band is the moving average + 2 standard deviations.
• The lower band is the moving average - 2 standard deviations.
When the price touches or crosses the upper band, the stock may be overbought. When it touches or dips below the lower band, the stock may be oversold. Traders watch for "bounces" off the bands or breakouts when price pushes past them.
Bollinger Bands help traders spot price extremes and potential reversals. They're also useful during periods of low or high volatility. Narrow bands can signal an upcoming breakout, while wide bands may suggest the stock is highly volatile.
Example: A penny stock’s price touches the lower band after a sharp drop. If volume spikes and RSI shows oversold, it could be a signal to buy on a bounce.