Bollinger Bands are similar to upper and lower envelopes that surround the stock price on a chart. They are generally plotted as two standard deviations away from a simple moving average. This is the primary difference between Bollinger Bands and envelopes. Envelopes are plotted a fixed percentage above and below a moving average but Bollinger Bands adjust themselves to current market conditions because standard deviation is a measure of volatility. They widen during volatile markets and contract during the less volatile periods.

Occasionally, Bollinger Bands are displayed with a simple moving average line. The time period for the moving average can vary but 10 days is most common for short term trading. The SD value can also be increased or decreased to suit your personal preference. Most technicians lower the value to 1-1/2 standard deviations away from the moving average when using a 10-day moving average.

Bollinger Bands do not provide the complete picture and should be used with another indicator. When price touches one of the bands, it could indicate a continuation of the trend or a reversal in the other direction. Most technicians use the RSI or MACD to confirm the indications. RSI is an excellent indicator with respect to the overbought and oversold conditions. Generally, when price touches the upper band, and RSI is below 70, the trend will continue. The opposite is true for the lower band, and RSI indications above 30. Conversely, when the price touches the upper band and RSI is near 75-80, the trend may reverse itself and move downward. The same condition exists when the price touches the lower band and RSI is below 25-20.

One thing to remember; don't use indicators that rely on the same inputs to confirm the Bollinger band indication. MACD and RSI fall into this category. Consider using On Balance Volume or the Money Stream. RSI, On Balance Volume, and Money Stream measure different things and can be used together as further confirmation of a trend.