What is a Bulge?
A bulge, or bulge line, refers to a plot line that represents a specified number of standard deviations above the middle of a Bollinger Band® indicator. The mid-point is typically a 20-day simple moving average (SMA) of the asset's price. Therefore, the bulge line is the upper most line on the Bollinger Band® technical analysis indicator.
- The bulge is the upper line of a Bollinger Band indicator.
- It is typically located two standard deviations above the Bollinger Band® mid-line.
- The bulge is used to analyze the strength of an upward price move, and also provide potential sell signals when the price falls below a recent swing low after not reaching the bulge.
What the Bulge Tells You
A bulge, or bulge line, is a pivotal component of Bollinger Bands®, a technical indicator developed by analyst, investor, and author John Bollinger. They are a set of three lines:
- The 20-day simple moving average of an asset's price, which is the middle line.
- An upper line, or bulge, which is a specified number of standard deviations above the middle line.
- The lower line, which is a specified number of standard deviations below the middle line.
How many standard deviations are used is discretionary, but the default is two standard deviations.
Standard deviation is a statistical concept that describes the average distance of data points in a sample from the average of that sample. In stock trading, standard deviation is a measure of volatility. The larger a standard deviation in a set of stock prices, the higher its volatility.
According to John Bollinger, in his book, Bollinger on Bollinger Bands, “Bollinger Bands® are bands drawn in and around the price structure of a chart. Their purpose is to provide relative definitions of high and low; prices near the upper band are high, prices near the lower band are low.”
The bulge can be an important tool for users of Bollinger Bands® to decide when to buy, sell, or short sell.
Bollinger Band Bulge Strategies
There are multiple Bollinger Band strategies. Here we will focus on some standard interpretations of the upper band.
One of the first uses is trading M-tops. This is when the price makes a high, pulls back, then makes a similar high (could be slightly higher, lower, or equal) but fails to touch the Bollinger Band bulge. When the price drops back below the pull back low, that is a sell signal. This is similar to a double top formation.
As a more general guideline, when the price touches the upper band, that shows price strength. It isn't a buy or sell indication in and of itself, but it can help with analysis. If a price is continually hitting the upper hand, and typically not reaching the lower band, that asset is likely moving strongly higher.
Example of Bollinger Band Bulge in a Stock
The chart of Facebook Inc. (FB) shows a M-top pattern using the Bollinger Bands®. The price rises along the bulge. Then it pulls back and tries to rally again. The price isn't able to match the prior high, but more importantly the price doesn't touch the bulge on this second attempt. Then price then proceeds to drop below the pullback low. This was an opportunity to sell prior to a substantial price decline.
Not all examples of this pattern will result in a large price drop.
The Difference Between the Bulge and Envelopes
The bulge is typically two standard deviations above the mid-point of the Bollinger Band®. Envelopes are a different indicator, with a similar look. Envelopes are typically moving averages placed above and below another moving average, or the upper and lower bands are placed a certain percentage or dollar amount above and below a mid-point to create an envelope around the price.
Limitations of Using the Bulge
The bulge is placed a specified number of standard deviations away from an SMA. The chosen settings may have little predictive ability. Price will run through the bulge sometimes, other times it won't reach it.
One knock against using standard deviations is that many use them assuming that returns and risk are based on a normal distribution. Because of trends, they are not.
Bollinger Bands® are best used in conjunction with other indicators and price action. Like the M-top example, this techniques looks for multiple price factors as well as confirmation from the Bollinger Band® to trigger a trade.
No indicator works all the time. Also, different assets may require different settings for the indicator in order to be useful.