Bollinger bands, or BB, have been created in the 1980s by John Bollinger.
It's an overlay indicator, meaning it shows above the price.
It consists of three lines:
For curious people, here are the formulas:
The middle band is nothing more than a moving average, applied on the closing price (as it should be) of the 20 previous candles: you would get the exact same result by adding a MA with a value of 20.
The lower and upper bands are derived from a moving average and a standard deviation (stdDev).
BB allow you to:
This is the central concept of Bollinger's indicator. It gives you a visual aid to evaluate the volatility.
The band expend in periods of strong movements, and contract during consolidations.
And, after all, the market is a sequence of trends and consolidations. Therefore, when the band is tight, it should at some point result in a breakout, as you can see below:
In this example, all breakouts are bullish. But this is only a coincidence, it could as well go south-way:
Candles can and will, at some point, get outsides the bands.
It will mean that:
It can be hard to distinguish one from the other, when the price is developing. For example, if the price get above the upper band, does it mean we are in an overbought condition, and that we should sell? Or is it the start of a new leg-up, and we'd better buy?
BB alone does not let you identify the difference early enough. You have to use other tools, such as horizontal S/R or trend-lines.
During a consolidation, when the price touch or get outside the bands, we can see that as a buy/sell signal:
In these side-way price actions, BB can be useful, especially on the hours and minutes charts.
However you have to be careful not to miss the incoming trend. This risk is why swing and position traders usually don't trade those narrow moves.
As you see on the following screenshot, this market then went into a +275% bull run, after 9th October to 11th December's consolidation.
In a trend, let it be bullish or bearish, it's a good sign when candles close outside the bands. You could compare this with the RSI reaching a high number such as 80, or 20 for bear-trends: we have ferocious buyers/sellers here.