Bollinger Bands are one of the most popular volatility indicators around and they look a lot more complicated than they are. It's just three lines on your price chart. Once you know what those lines are actually doing you can use them to identify overextended moves, the quiet periods that often precede a big breakout and the strength of a trend.
The middle line is a simple moving average (typically the 20 period). The upper and lower bands are two standard deviations above and below that average. Standard deviation is just a measure of how spread out prices have been in the recent past. In a calm market where prices don't move much the bands will be tight together. In a volatile market the bands will be far apart. The bands therefore automatically adapt to the current conditions rather than remain a fixed distance from price.
The most common error that novices make is to treat the bands as automatic buy and sell lines. They hear that when price touches the top band it's overbought and when it touches the bottom it's oversold and so they short every time it touches the top and go long every time it touches the bottom. That'll work in a sideways market, it won't work at all in a strong trend. In a strong uptrend price can stay on the top band for days, weeks even and anyone who's shorted it is going to get absolutely creamed. A touch of the band is not a reversal in itself. It merely tells you that price is a long way from its recent average.
A far better way to look at them is as a trend strength indicator. In a good uptrend you'd expect price to be trading between the middle line and the upper band and the pullbacks would typically find support right around the 20 period average in the middle. In a downtrend you'd see the same thing in reverse with price trading between the middle line and the lower band. If the stock is continually pulling back to the middle line and bouncing off it, that's a good indication of an orderly trend with buyers holding the trend. If price starts to close below the middle line after a long run, that’s an early warning that the trend may be losing its strength.
The setup that gets the most attention is the volatility squeeze. Markets move in cycles from quiet to active. When the bands are at their narrowest for a while, that's a sign that volatility has dried up and that's rarely going to last. A big move is usually going to follow as the compressed energy releases. The problem with the squeeze is that it doesn’t tell you which way the breakout will go. That’s why you wait for price to actually break the range (ideally on a jump in volume) before you do anything. A lot of traders will simply watch for a strong close outside the band following a squeeze and then use the middle line or the low of the breakout candle as their stop.
Another useful pattern is the walk along the band. If price is repeatedly closing at or near the upper band whilst the bands themselves are expanding, that's often a strong momentum phase rather than a top. To exit a good trade simply because it's touched the upper band is one of the most common mistakes traders make in terms of cutting their winners short. If you’re in a winning trade it can be quite sensible to trail your stop under the middle line or under recent swing lows and let the trend tell you when it’s time to exit.
Reversals do occur at the bands but they're generally accompanied by further evidence. If price moves above the upper band, closes back down into the band with a long upper wick and you've got bearish divergence on the RSI, that’s a much stronger signal than just a simple band touch. The same applies at the lower band. You're looking for a reaction from price, not simply the fact that the band has been breached.
A few practical tips make a massive difference. Start with the defaults of 20 periods and 2 standard deviations on the daily chart unless you have a very good reason to deviate. The constant fiddling with the settings tends to just make it work on the old data and break down on the new. Always look at the broader context. A squeeze setup on a stock sitting right at the base of a major resistance level is a very different proposition to one in the middle of a big open space. Don't forget to look at volume. A breakout from a squeeze on weak volume is far more likely to fail than one that's backed by a big spike in volume.
The best way to get used to the tool is to go through the historical charts of the stocks you're following and simply flag every squeeze you can see. Then look at what happens afterwards. How long did the compression last? What direction did it break in? How far did it go? How often did it fake out first? After doing this a few dozen times you start to pick up the difference between a genuine squeeze that’s about to expand and a quiet compression that's just going to keep drifting.