Bollinger Bands : Technical Analysis Indicator
Bollinger Bands help the traders to establish the direction of trends, spot the potential reversals and to monitor the market volatility. In essence, Bollinger Bands trading tool tells us about the market whether it is quiet or whether it is loud!. The bands will contract when the market is quiet, and the bands will expand when the market is loud.
John Bollinger an American Author, financial analyst and contributor to technical analyst developed a technical indicator which is called Bollinger Bands. They are the most famous technical indicators used by today’s traders. It is related to the bands (Price transmission) located on a chart in which a specific security price shifts up or down to represent a volatility range.
Basics of the Bollinger Bands
Three lines are presented in Bollinger Bands: the lower band, middle band, upper band. The moving averages of prices are in the middle line, the trader chooses the parameters of the moving average, the upper and the lower bands are drawn on either side of the moving average. The standard deviation determined the distance between the upper, and the lower bands. It is determined by the traders how many standard deviations they want to set the indicator at, although many of the traders use two deviations.
How to Trade with Bollinger Bands
When we use Bollinger Bands in trading, it defines the lower and upper bands as price targets. Some traders buy when the price reached the lower bands and exit the trade when the price reached the moving average in the center of the bands. Some traders sell when the price reached or falls below the lower band or buy when the price reached above the upper band.
Why Bollinger Bands Useful for Traders
- Bollinger Bands can be very useful in deciding price pattern, reading the strength of trend, during range markets time entries, finding potential market tops in a dynamic, and adaptive manner, in markets that tend to be rather volatile.
- Bollinger bands are mostly used as coupled with other indicators, so we can say that it can offer an objective aspect of the market and perform as a key decision zone for different trading strategies.
- Bollinger Bands are able to use waves as an independent tool for complement to other tools and technical analysis.
Overbought and Oversold Strategy
Many traders are in favour of overbought and oversold strategies. It depends on the mean reversion of the price, and it heavily relies on the Bollinger Bands. If the price deviates from the average, mean reversion expects that, it will eventually revert back to the mean price. Assets price that has deviated from the mean, is identified by the Bollinger Bands. A trader can enter a long position seeking the price to revert back to the moving average, when the price of the asset is below the lower band. Conversely, the trader can short the asset on a move back to the middle band, when the price is above the upper band.
When the price bands come closer together this situation is called the squeeze. Similar periods indicate current low volatility and the potential in the near future for the high volatility. However, when the volatility is expected to increase, the trader does not provide trader with the information on a specific point in time. During the squeeze the traders remain inactive most of the time.
In Bollinger bands between the price bands approximately 90% of price action takes place. Breakouts are the events that take place in the remaining 10% of the time. An event during which price action leaves the “normal” price limit is called a breakout. They do not give any information regarding future trends and direction so, they should not be used as trading signals.
Combine and Conquer
To show current volatility and predicting upcoming market fluctuations Bollinger Bands are good, but they are not a universal trading tool. Maximum prediction and effectiveness this indicator should be combined with the other indicators, according to Mr. Bollinger himself.
Bollinger Bands are used in real life trading and are worth learning indicator. Traders can use them for creating their own trading system and trading approaches. They are used by most of the traders around the globe in many markets in a wide range of approaches. As they are adapted and applied in new ways they continue to work year after years, because they are tools not a system.