What is a lump?
A bulge, or bulge line, refers to a graphical line that represents a specific number of standard deviations above the middle of a Bollinger Band® indicator. The midpoint is usually a 20-day Simple Moving Average (SMA) of the asset’s price. Therefore, the bulge line is the highest line on the Bollinger Band® technical analysis indicator.
- The bulge is the top line of a Bollinger band indicator.
- It is typically two standard deviations above the Bollinger Band® midline.
- The surge is used to analyze the strength of an upward price movement and also provide potential sell signals when the price falls below a recent low after missing the rise.
What the lump tells you
A bump, or bump line, is a fundamental 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 midline.
- An upper line or bulge, which is a specific number of standard deviations above the midline.
- The bottom line, which is a specified number of standard deviations below the midline.
The number of standard deviations 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, the standard deviation is a measure of volatility. The higher the 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. Its 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 lump can be an important tool for Bollinger Bands® users to decide when to buy, sell or sell short.
Bollinger band bulging strategies
There are multiple Bollinger Band strategies. Here we will focus on some standard performances of the top band.
One of the first uses is to swap M-tops. This is when the price rises, retreats, and then hits a similar high (it could be a bit higher, lower, or the same) but does not touch the bulge of the Bollinger Band. When the price falls back below the retracement low, it 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 the strength of the price. It is not an indication of buying or selling in itself, but it can help with analysis. If a price continually hits the top and typically misses the bottom band, that asset is likely to move strongly higher.
Example of a bulging Bollinger band in a stock
The Facebook Inc. (FB) chart shows an M-top pattern using Bollinger Bands®. The price rises along the package. Then back off and try to recover again. The price cannot match the previous high, but more importantly, the price does not touch the lump on this second attempt. The price then proceeds to fall below the retracement low. This was an opportunity to sell before a substantial price drop.
Not all examples of this pattern will result in a big price drop.
The difference between the bulk and the envelopes
The bulge is typically two standard deviations above the midpoint of the Bollinger Band®. Envelopes are a different indicator, looking similar. Envelopes are typically moving averages placed above and below another moving average, or the upper and lower bands are placed by a certain percentage or dollar amount above and below a midpoint to create an envelope around the price.
Limitations of using Bulge
The bulge is positioned at a specific number of standard deviations from one SMA. The chosen configuration may have little predictability. Price will break through the bundle sometimes, other times it won’t reach it.
One drawback to using standard deviations is that many use them assuming that returns and risk are based on a normal distribution. Due to trends, they are not.
Bollinger Bands® are best used in conjunction with other indicators and price action. Similar to the M-top example, this technique 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 to be useful.