Developed by John Bollinger, Bollinger Bands are based on ordinary Moving Averages that compare volatility and associated price levels over time. The band lines are offset by a negative and positive standard deviation on either side of a simple moving average, which runs through the middle.

To determine the settings of the Bollinger Bands we must first understand what Standard Deviation is. The Standard Deviation determines the volatility of the market; how much the current value deviates from the average price. Closing prices are most often used for Bollinger Bands, so if we were using the closing price of each bar as the value we then are measuring how far away the current close is from the average distance between closing prices.

Lets take a look at what these price bands look like;

Bollinger Bands should take in the majority of price the markets movement, but not all. When the market makes quick movements it is not uncommon that the price will briefly trade outside of the bands, if this happens too often then you will need to change to a longer moving average, or vice versa, if the market barely touches the outer lines of the bands then a shorter time frame moving average should be used.
A better way to determine the average length of the moving average is to set it by a higher low following a bottom. The lower moving average of the band should act as support for the new higher low created. Let’s check this out in two images showing a correct setting and one that is vastly off.

As you can see in the image below, the ‘Higher Low’ has found support on the lower band line.

In this next image you can see how the lower band does not provide support to the market as it creates a higher low like it does in the previous image;

Version 2.0