Bollinger Bands: how they are built, what the squeeze means and how to trade them

Bollinger Bands are a volatility indicator made of three lines drawn on the price chart: a 20-period simple moving average in the middle, and an upper and lower band set two standard deviations above and below it. John Bollinger developed them in the 1980s. The bands widen when price swings more and narrow when it quietens, so they show how stretched price is.

In short

• The middle band is a 20-period simple moving average. The upper and lower bands sit two standard deviations of price above and below it.
• A touch of a band is not a signal. In a trend, price can run along the upper or lower band for many candles.
• A squeeze, when the bands narrow to a low width, shows quiet trading that often precedes a larger move. It does not show which way.
• The two main uses are reversion to the middle band in a range and continuation when price walks a band in a trend.
• On a $10,000 Direct account, a 30-pip stop on 0.33 lots of GBP/USD risks about $99, a quarter of the $400 first-day daily loss limit.

What are Bollinger Bands?

Bollinger Bands are two lines that wrap price at a distance set by its recent volatility. The middle line is a moving average. The outer lines move with how much price has been swinging, so they widen in a fast market and tighten in a slow one.

About 95% of values fall within two standard deviations of the mean if prices follow a normal distribution. Market prices do not follow one closely, so the figure is only a rough guide, and price spends more time outside the bands than the maths suggests, particularly in a trend. That is why a touch of the band is not a sell signal.

The bands are one of the indicators in the Academy indicators lesson, which also covers moving averages, RSI, MACD and VWAP. They are a volatility tool, where the others measure trend or momentum.

How are Bollinger Bands calculated?

The middle band is the simple moving average of the last 20 closes. The upper band is the middle band plus two standard deviations of those closes, and the lower band is the middle band minus two. The standard deviation measures how far closes are scattered around their average.

To see the standard deviation, use five closes on GBP/USD: 1.2640, 1.2650, 1.2660, 1.2650 and 1.2650.

1. The average is 1.2650.
2. The gaps from the average are -10, 0, +10, 0 and 0 pips.
3. The squares are 100, 0, 100, 0 and 0, which add up to 200.
4. Divide by 5 to get 40, and take the square root: the standard deviation is 6.3 pips.

With 20 closes the sum is the same, only longer. If the 20-period average is 1.2650 and the standard deviation is 25 pips, the upper band is 1.2650 + 0.0050 = 1.2700 and the lower band is 1.2600. The bands are 100 pips apart. If the standard deviation drops to 10 pips, they are 40 pips apart. The platform calculates all this, and the numbers show why the bands move when volatility does.

What does the Bollinger Band squeeze mean?

A squeeze is a period when the bands move close together, showing that volatility has fallen to a low. Markets alternate between quiet and active, so a squeeze often comes before a larger move. The bands show that a move may be coming, not which way it will go.

Traders measure it with band width, the gap between the bands divided by the middle band. A width at its lowest in six months is a squeeze by most definitions. The method is simple: mark the squeeze, wait for a candle to close outside the range, and trade in the direction of the break with the stop on the other side.

The early move can be a false one. Price often breaks one way, returns and then goes the other, so some traders wait for a second candle to close outside, or a retest. A squeeze before a scheduled release, such as the US jobs report, is mostly a market waiting for the number, and the move comes with the release. News trading is allowed on CMC Funded, though spreads can widen, so plan the size for the stop that the volatility needs.

Does price reverse at the bands or follow them?

Both happen, and which one depends on the market. In a range, price tends to return to the middle after touching a band. In a trend, price can stay near a band for a long time, which traders call walking the band. The same touch means opposite things in the two cases.

The test of which case you are in comes before the signal. Look at the middle band: if it is flat and price crosses it often, the market is ranging. If it slopes and price stays on one side of it, the market is trending. The mean reversion guide explains the range case and the trend following guide the trend case.

How do you trade with Bollinger Bands?

The two main methods are the range reversion to the middle band and the trend pullback to the middle band. Both use the middle band as the target or the entry, and both need a check of the market first. A stand-alone band touch is a weak reason to trade.

1. Range reversion. When price closes outside a band and the next candle closes back inside, trade back toward the middle band. Put the stop beyond the extreme of the move.
2. Trend pullback. In a rising trend with price above the middle band, buy a pullback to the middle band when a candle closes back up. The stop goes below the pullback low.
3. Squeeze break. After a squeeze, trade a candle that closes outside the band, with the stop at the other side of the squeeze.

Add a second reason. An RSI reading beyond 70 or 30 at the band touch, as in the RSI indicator guide, or a support level at the same price, gives more evidence than the band alone.

What does a Bollinger Bands trade look like with real numbers?

This example is a range reversion buy on a 1-hour GBP/USD chart, on a $10,000 Direct account risking 1% per trade, which is $100. One standard lot of GBP/USD is worth $10 a pip. The prices are made up for teaching.

1. GBP/USD has moved sideways for two days. The middle band is flat at 1.2650 and the lower band is at 1.2600.
2. A candle closes at 1.2596, below the lower band. The next candle closes back inside at 1.2606. Buy at 1.2606.
3. The stop goes at 1.2576, 4 pips below the low of the move at 1.2580. The risk is 30 pips.
4. Size: $100 / (30 x $10) = 0.333 lots, rounded down to 0.33. A pip is $3.30, so the risk is 30 x $3.30 = $99.
5. The target is the middle band at 1.2650, 44 pips away. That is worth 44 x $3.30 = $145.20, a ratio of 1.5 to 1.

The ratio is lower than in many setups, because the target is close. At 1.5 to 1 you need to win more than two trades in five to break even before costs. Now the failure case: if the middle band slopes down and price keeps closing below the lower band, the market is trending, and the buy loses at 1.2576. Simulated trades carry costs like a live account: a commission when a trade opens and closes, and holding costs on positions kept overnight.

How this works on CMC Funded

On a $10,000 Direct account the daily loss limit is 4% of the day's starting equity, which is $400 on the first day, and the maximum loss is a fixed 6%, so the floor is $9,400. The limit is measured on equity, so a floating loss counts before you close the trade. The $99 trade uses about a quarter of the daily limit.

The bands change the stop you need. In a wide-band market, a 30-pip stop may be inside the normal noise. In a squeeze, the same stop is wide. Check the band width before you set the stop, and size the position to it. The Direct route needs at least 3 trading days with a profit target of 10%, $1,000 on this account, and no time limit, so you can wait for a clear setup.

On the Classic route the daily limit is 5% and the maximum loss 10%. Trading is simulated and costs are modelled, so short reversion targets such as 44 pips lose a visible share to the spread and commission. Read the rules for the definitions, and use the position size calculator.

Do Bollinger Bands work?

Bollinger Bands describe volatility, and no setting has been shown to produce reliable profits on its own. They are a map of how stretched price is, and what you do with that is a strategy that has to be tested. Reversion in a range and breaks after a squeeze both work in some periods and fail in others.

The risk is mixing the two cases. A rule that fades band touches wins in ranges and loses in trends, and the losses in trends are large. To test your rule, mark 50 band touches on one pair, label each as a range or a trend by a fixed rule and record the outcome. The trading journal template guide shows what to log.

Common mistakes

• Selling every touch of the upper band. In a trend, price walks the band and each fade loses.
• Reading the squeeze as a direction. It shows quiet, not which way the move will go.
• Ignoring the middle band. Its slope tells you range or trend.
• Changing the settings to fit. 20 and 2 are the standard, and a tuned setting fits the past.
• Using a target beyond the middle band in a range. The middle is the natural target, and the opposite band is rarely reached.
• Setting a stop inside the band noise. In a wide market, a tight stop is hit by normal swings.
• Sizing from the band and not the stop. The lots follow from the distance to the stop, 30 pips here.

Questions traders ask

What are the best Bollinger Bands settings?

The standard setting is a 20-period average with two standard deviations. Shorter periods respond faster and give more signals. Wider deviations, such as 2.5, give fewer touches. None has been shown to be better.

What does price touching the upper Bollinger Band mean?

It means price is more than two standard deviations above its 20-period average. In a range, it is often stretched. In a trend, it is often strength. Check the middle band's slope to tell which.

What is a Bollinger Band squeeze?

It is a period of low volatility in which the bands are close together. It often comes before a larger move, but it does not show the direction.

Can you use Bollinger Bands with MACD?

Yes. The bands show volatility and the stretch, and MACD shows momentum. The MACD indicator guide explains how its signals fit with a band trade.

Next steps

The Academy indicators lesson covers Bollinger Bands next to the other main indicators with practice questions. The moving average crossover guide explains the average that the middle band is made from. Size each trade from its stop with the position size calculator, and read the loss limits on the rules page.

You can compare the Classic and Direct routes on the challenges page.