Bollinger Bands explained: squeeze, band walks and mean reversion

Bollinger Bands are an envelope around price that widens when the market becomes more volatile and narrows when it calms down. Developed by John Bollinger in the 1980s, they answer a question most indicators ignore: relative to recent behaviour, is this price unusually high, unusually low, or perfectly ordinary?

How the bands are built

The standard settings are a 20-period window and 2 standard deviations:

• Middle band = the 20-period simple moving average of the close.
• Upper band = middle band + 2 × the standard deviation of the last 20 closes.
• Lower band = middle band − 2 × the same standard deviation.

Standard deviation measures how spread out the recent closes are. When closes cluster tightly around the average, it is small and the bands hug price. When closes swing widely, it grows and the bands move apart. That is why Bollinger Bands double as a volatility gauge.

A common rule of thumb is that most closes fall inside the bands. Treat that as a loose description, not a probability you can trade on: market returns have fatter tails than the bell curve assumes, so closes outside the bands are more frequent than textbook statistics suggest.

A worked example

Suppose the last 20 M1 closes on EUR/USD average 1.08500 and their standard deviation is 0.00015 (1.5 pips).

• Middle band = 1.08500
• Upper band = 1.08500 + 2 × 0.00015 = 1.08530
• Lower band = 1.08500 − 2 × 0.00015 = 1.08470

The band width is 6 pips. Now a sharp candle closes at 1.08540, above the upper band. Two very different things could be happening: a short spike that will fade back toward 1.08500, or the start of a move that will drag the bands up with it. The bands alone cannot tell you which. What they do tell you is that this close is large relative to the last 20 minutes.

If, an hour later, the standard deviation has fallen to 0.00005, the bands are only 2 pips wide. That is a squeeze.

The squeeze

A squeeze is a period when the bands become unusually narrow compared with their recent history. It reflects the volatility clustering described in volatility explained: quiet periods tend to end with expansion.

The catch: a squeeze does not tell you the direction. Price can break out of it upward or downward, and the first move out is often a fake that reverses into the real one. Many traders treat a squeeze as a signal to pay attention, then use structure, levels or a candle close beyond a support or resistance zone to decide on direction. See breakouts and false breakouts for why that first move is so unreliable.

Walking the bands

In a strong trend, price can "walk" along one band: in an uptrend, candles repeatedly close near or above the upper band while the band itself slopes upward. This is the single most important thing to understand about Bollinger Bands, because it contradicts the beginner's instinct that touching the upper band means price is "too high".

Signs of a band walk:

• The bands are widening and sloping in the same direction.
• Pullbacks stop near the middle band rather than reaching the opposite band.
• Candles close near the outer band, not just wick into it.

Fading a band walk — taking Lower trades because price touched the upper band — is one of the most common ways to lose several trades in a row.

Mean reversion vs breakout

Bollinger Bands support two opposite ideas, and the art is knowing which one applies:

The same touch of the upper band means "possible reversion" in the first row and "trend strength" in the second. If you cannot tell which row you are in, that is useful information too: it is often a good moment not to trade.

Bollinger Bands on short expiries

On second-based charts like S5 or S15, each band is computed from very few ticks, so the bands jump around and closes beyond them are common and meaningless. For trades of 1–5 minutes, reading the bands on M1 is usually more stable.

Mean-reversion trades on short expiries have a specific weakness: the reversion might come, but not within your expiry. Price that closes above the upper band can hover there for several candles before drifting back. If your trade lasts 30 seconds, it may expire before anything happens, or during the next push higher.

Typical mistakes and false signals

• Treating every touch of a band as a reversal signal.
• Ignoring band slope and width, which tell you whether you are in a range or a trend.
• Guessing the direction of a squeeze breakout.
• Assuming the 2 standard deviation envelope gives a precise probability.
• Expecting Bollinger signals to be predictive on OTC charts. On Sky Trade, OTC prices are generated by the server, do not track any real market and have an unpredictable next move; the bands only describe how spread out recent prices were.

How to add it in the Sky Trade terminal

Open the Indicators menu above the chart and switch on Bollinger in the Trend group; the bands are drawn on the price chart with a dashed middle line. The period starts at 20 and can be changed with the stepper; the width is fixed at 2 standard deviations.