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Bollinger Bands are lines which are a user-specified number of standard deviations above and below a simple moving average. For example, a 20-2.0 Bollinger Band overlay would display lines which are 2 standard deviations above and 2 standard deviations below a 20 day simple moving average of the price.
Bollinger Bands are not used to create trading signals by themselves but are rather combined with other indicators such as the relative strength index (rsi) or the the money flow index (mfi).
RSI and Bollinger Bands
Under the bollinger-band/rsi combined indicators, a buy signal is issued when the price is above the bollinger upper band and the rsi rises above 80% or the price is near the bollinger lower band and rsi rises above 20%. A sell is issued when the price is below the bollinger lower band and the rsi falls below 30% or the price is near the bollinger upper band and the rsi falls below 80%
Some explanations for the notes 1, 2, 3, and 4 in the above chart:
- there is a buy signal since the price is above the bollinger upper band and the rsi is greater than 80%
- there is a buy signal since the price is near the bollinger lower band and the rsi has risen above 20%
- there is a sell signal since the price is below the bollinger lower band and the rsi is less than 30%
- there is a sell signal since the price is near the bollinger upper band and the rsi has fallen below 80%
MFI and Bollinger Bands
Another method of setting trading signals is to trade when a "squeeze" occurs. A "squeeze" buy means that the money flow index is greater than and equal to 0.7 and the price has violated the lower Bollinger Band. A "squeeze" sell occurs when the money flow index is less than or equal to 0.3 and the price has violated the upper Bollinger Band.
