Mean Reversion · Volatility Bands · 1980s · Intraday / Swing
Bollinger Bands place a band two standard deviations above and below a 20-period moving average. The bands widen when volatility rises and narrow when it falls. The mean-reversion strategy treats a close outside the bands as a stretched move that's likely to snap back. It's one of the most popular uses of the bands, though John Bollinger himself never presented it as a stand-alone signal.
The middle band is a 20-period simple moving average, and the outer bands sit two standard deviations either side of it. In a range-bound market, a close below the lower band is treated as oversold relative to recent volatility. The trade buys it and targets a return to the middle band. The mirror trade sells closes above the upper band. The approach depends on the market actually being in a range. When a trend starts, price can ‘walk the band’, repeatedly closing at or beyond it, and fading those moves loses money quickly.
In a sideways market price spends most of its time between the bands — two standard deviations either side of a 20-period average (the dashed middle line).
A sharp drop closes outside the lower band. Statistically that's a stretched move, and the mean-reversion trade buys here, expecting a snap back.
Price recovers to the middle band — the usual profit target for this trade — and the range resumes.
Then the market starts trending and price 'walks' the upper band, closing near or outside it again and again. Fading these moves is how mean-reversion traders get hurt in trends.
Illustrative example only — not real market data.
The chart above shows both sides of the strategy: a textbook snap-back from below the lower band to the middle band, followed by a trend in which price walks the upper band. Bollinger's own warning applies: a touch of the band is just a touch, not a signal on its own.