Bollinger bands are a powerful stock indicator which signals a stock breakout. Bollinger Bands consist of a center line and two price channels (bands) above and below it. The center line is an exponential moving average; the price channels are the standard deviations of the stock being studied. The bands will expand and contract as the price action of an issue becomes volatile (expansion) or becomes bound into a tight trading pattern (contraction).
When stock prices continually touch the upper Bollinger band, the prices are thought to be overbought; conversely, when they continually touch the lower band, prices are thought to be oversold, triggering a buy signal. When using Bollinger bands, designate the upper and lower bands as price targets. If the price deflects off the lower band and crosses above the 20-day average (the middle line), the upper band comes to represent the upper price target. In a strong uptrend, prices usually fluctuate between the upper band and the 20-day moving average. When that happens, a crossing below the 20-day moving average warns of a trend reversal to the downside. (For more about gauging an asset’s direction and profiting from it, see Track Stock Prices With Trendlines.)