How Bollinger Band Indicator Works

Bollinger Band indicator calculations uses standard deviation to plot the bands, default value used is 2.

Bollinger Band Stock Indices Calculation

The middle Bollinger band line is a simple moving average

The upper Bollinger band line is: Middle line + Standard Deviation

The lower Bollinger band line is: Middle line - Standard Deviation

Bollinger bands indicator considers the best default moving average to calculate the Bollinger bands to be 20 periods moving average and the bands are then overlaid on the trade chart price action.

Standard Deviation is a statistics concept. It originates from the notion of normal distribution. One standard deviation away from the mean either plus or minus, will enclose 67.5 % of all price action movement. Two standard deviations away from the mean either plus or minus, will enclose 95 % of all price action movement.

This is why the Bollinger Band indicator uses the standard deviation of 2 which will enclose 95 % of all price action. Only 5 % of Stock Indices trade chart price action will be outside the 3 Stock Indices bollinger bands, this is why Stock Indices traders open or close trades when price hits one of the outer Bollinger Band.

The Bollinger Band indicator main function is to measure price action volatility. What the Bollinger bands upper & lower limits try to do is to confine price action of up to 95 percent of the possible closing Stock Indices prices.

Bollinger Band indicator compares the current closing price with the moving average of the closing price. The difference between these two prices is the volatility of the current price compared to the moving average. The price volatility will increase or decrease the standard deviation of the bollinger bands indicator.