Technical Analysis - Introduction to Bollinger Bands

 Bollinger Bands were developed by John Bollinger as a specialized trading tool in early 1980s. They

arose from the need for adaptive trading bands and the observation that volatility wasn’t static as was widely believed, but dynamic. Bollinger developed the technique of using moving averages with two trading bands. This isn’t unlike utilizing an envelope on either side of a moving average. However, unlike utilizing a percentage computation from the normal moving average, Bollinger Bands add and subtract a standard deviation calculation.

bollinger bands are accustomed to give a definition of relative high and low. That is an indication of prices being “high” at one end and “low” at the other end. By using this definition can assist in recognizing rigorous patterns and pays to in the comparison of price action to indicator action when arriving at systematic trading decisions.

Components

Bollinger Bands consist of a centerline and two price channels. One price channel is above the centerline, and the other is below the centerline. This centerline is an exponential moving average. The purchase price channels are standard deviations of the stock being studied by the chartist. Therefore, the definition of a “price channel” in this regard identifies the encompassment of the trading activity around the trend of trading after a sharp rise or fall in the market. The bands will expand and contract as the price action of an issue becomes volatile (this is expansion) or becomes bound into a tight trading pattern (the definition of contraction).

The center Bollinger Band equals a 20-period moving average. The top of Bollinger Bands includes the middle Bollinger Band plus the total of two 20-period standard deviations. The reduced Bollinger Band is comparable to the middle Bollinger Band minus the total of two 20-period standard deviations.

What Bollinger Bands Measure

Two important tools are derivative of the Bollinger Bands. BandWidth, which really is a relative measure of the width of the bands, is the first tool. BandWidth is calculated by dividing the result of top of the Bollinger Brand minus the lower Bollinger Band by the middle Bollinger Band. That is frequently used to quantify “The Squeeze, “ volatility based trading opportunity. The next tool derived from Bollinger Bands is %b. this can be a measure of where the last price is in terms of the bands. That is calculated by dividing the result of the last minus the lower Bollinger Band by top of the Bollinger Band minus the lower Bollinger Band. %b is frequently used to clarify trading patterns. It is also used as an insight for trading systems.

Markets trade erratically on a daily basis even though they’re still trading either when they’re up in the trend or down in the trend. Moving averages are used with support and resistance lines to anticipate the stock’s price action. These upper resistance and lower support lines are first drawn and then extrapolated to form channels. The trader expects prices to be contained within these formulated channels. Sometimes, straight lines are drawn connecting either tops or bottoms of prices to be able to identify top of the or cheap extremes (respectively). Parallel lines are then included with define the channel within which the values should move. As long as prices stay in this channel, traders can be reasonably confident that prices are moving as expected.

Benefits of Bollinger Bands

• Use them to trade trends
• Identify early reversal signals
• Exhibit how strong (tradeable a stock’s move is
• Reveal a good way to trade break outs

General Uses/Indications from the Bands

• Once the stock price touches top of the Bollinger Band continually, the price is regarded as overbought.
• when stock prices continually touch the lower band of the Bollinger Band, the values are considered “oversold,” and thusly a purchase signal would kick in.
• Designate top of the and lower bands as price targets when using Bollinger Bands. If the price deflects off the lower band and crosses above the middle line (the 20-day average), then the upper band involves represent top of the price target. Prices usually fluctuate between top of the band and the 20-day moving average in a solid uptrend. At these times, a crossing below the middle line warns of a reversal in trends to the downside (lower band).
• Trending stocks will Walk the Bands Stocks touching the upperband come in and uptrend. Stock touching the lowerband come in a downtrend. Channeling stocks will not touch the bands.

General Trading Rules

Usage of the Bollinger Band among traders varies wildly. Some traders buy when the price touches the lower Bollinger Band and sell when price touches the moving average in the biggest market of the bands. Conversely, other traders buy when price breaks above top of the Bollinger Band or sell when price falls beneath the lower Bollinger Band.

Bollinger Bands can be used in conjunction with price action and other indicators to generate signals and foreshadow significant moves. A “double bottom buy” signal is given when prices penetrate the lower band and remain above the lower band after a subsequent low forms. It doesn’t matter which low is higher or less than the other one, so long as the next low stays above the lower band. On the other hand, a “double top sell” signal is given when the values peak above top of the band and the following peak doesn’t break above top of the band.

Not only stock traders utilize the Bollinger Band. Options traders (especially implied volatility traders) often sell options when Bollinger Bands are at their most historic difference or buy when Bollinger Bands are at their closest historic point. They do this with the expectation that volatility will revert back toward the average historical volatility level for the stock.

In summary, Bollinger Bands are helpful when generating buy and sell signals. They’re not, however, designed to find out the near future direction of a security. The Bands were designed to increase other analysis techniques and indicators. In general, Bollinger Bands serve two primary functions: the identification of low and high volatility periods, and the detection of periods when prices are at an extreme and possibly unsustainable level.