Similar to the envelope technique, Bollinger Bands are placed two standard deviations above and below a moving average, which is usually 20 days. Using two standard deviations ensures that 95% of the price data will fall between the two tarding bands. As a rule, prices are considered to beoverextended on the upside (overbought) when they touch the upper band. They are considered overextended on the downside (oversold) when they touch the lower band.

The simplest way to use Bollinger Bands is to use the upper and lower bands as price targets. If prices bounce off the lower band and cross above the 20 day average, the upper band becomes the upper price target. A crossing below the 20 day average would identify the lower band as the downside target. In a strong uptrend, prices will usually fluctuate between te upper band and the 20 day average. In that case, a crossing below the 20 day average warns of a trend reversal to the downside.

Bollinger Bands expand and contract based on the last 20 days’ volatility. During a period of rising price volatility, the distance between the two bands will widen. Conversey, during a period of low market volatility, the distance between the two bands will contract. When the bands are unusually far apart, that is often a sign that the current trend may be ending. When the distance between the two bands has narrowed too far, that is often a sign that a market may be about to initiate a new trend.

Bollinger Bands work best when combined with overbought/oversold oscillators.