Bollinger Bands Indicator: Developed by John Bollinger, the Bollinger Bands look quite similar to the moving average Envelopes indicator. The major difference being that Bollinger Bands upper and lower bands change based on volatility, whereas the moving average envelope’s upper and lower bands are at fixed levels.
The Bollinger band is constructed by first applying a 20 period moving average line. The upper and lower bands are then plotted 2 standard deviations away from the moving average line. As price tends to increase in its range, the volatility increases and so does the standard deviation thus the upper and lower bands tend to expand and contract representing rising and falling volatility. The Bollinger Bands usually default to 20, 2 settings with other common settings including 40 and 2. Whole trading systems have been designed by making use multiple Bollinger Bands with different standard deviations.
The Bollinger bands are also used to represent trend as it is built up on the moving average. Buy and sell signals are triggered when prices tap or close above or below the upper or lower bands. In periods of extreme volatility, especially seen during break outs, price tends to trade close to the upper or lower bands for extended periods of time. Trend signals are also generated when the bands are expanding and price breaks the upper or lower bands, signaling a continuation of the trend in the direction of the break out.