Bollinger Bands ® Explained

22 January 2021

This way, traders can gather important information about how the market is trading. For example, after a sharp rise or fall in the trend, the market may consolidate, trading in a narrow fashion and crisscrossing above and below the moving average. To better monitor this behavior, traders use the price channels, which encompass the trading activity around the trend.

What is the best RSI period?

The best timeframe for RSI lies between 2 to 6. While the default 14 periods are fine for many situations, intermediate and advanced traders can decrease or increase the RSI timeframe slightly depending on whether the position they are entering is long-term or short-term.

In 2011, Mr. Pines started his own consulting firm through which he advises law firms and investment professionals on issues related to trading, and derivatives. Lawrence has served as an expert witness in a number of high profile trials in US Federal and international courts. Also see our guide to understanding the basics of reading candlestick charts and option trading strategies. Hence, selling options when Bollinger Bands are far apart, potentially could be a smart options volatility strategy.

A Tool For Trend Traders And Faders

Combining Bollinger Bands with M and W price patterns aids in spotting major reversal signals. They are always based on historical information and therefore react to price changes, but don’t anticipate price changes. Like other indicators, Bollinger Bands are best used in conjunction with other indicators, price analysis and risk management as part of an overall trading plan. These differences lead Keltner Channels to be smoother than Bollinger Bands since the standard deviation is more volatile than the average true range of a stock’s price. The lines indicate a volatility range in which a specific security price is moving up or down. Since standard deviation is a measure of volatility, the band is shown on the basis of standard deviation for a particular security, which is represented by lower or upper band.

The last paragraph will detail how I use the Bollinger Band Indicator. The assumption that the 2 SD bands contain 95% of the data applies only if it is correct to assume a Gaussian distribution of the data. It is only approximately correct if one assumes the data is unimodal and symmetrical. However, it is true for any data distribution that 2 SD boundaries contain more than 75% of all the data according to Chebychef’s Inequality. They provide a relative definition of whether the current price is high or low.

How To Day Trade With Bracket Orders

For the upper band, add the standard deviation to the moving average. For the lower band, subtract the standard deviation from the moving average. Prices have a tendency to bounce within the bands’ envelope, touching one band then moving to the other band. You can use these swings to help identify potential profit targets. For example, if a price bounces off the lower band and then crosses above the moving average, the upper band then becomes the profit target. continuously calculates and plots the average price the trades executed during specific time period increments. For example, a 15-minute 20 period moving average plots the average price of 20 x 15-minute periods on a continuous basis with a single line.

  • You can change these settings as well as the colors you would like the bands to show on your chart.
  • Bollinger Bands are created by two bands that run on either side of a SMA20 line.
  • When the price reaches the upper band/lower band, the chances of the price going further up/down decrease, but this does not mean that traders must enter opposite positions.
  • This is the stock of Home Depot and price was hugging the upper band giving little in the way of pullbacks to enter the move.
  • However, “relatively high” should not be regarded as bearish or as a sell signal.

Of course, these megatrends are rare, but with patience, discipline and luck we can catch such movements. As the Kumo cloud was inside the Bollinger Bands, we decided to short the market. Once we saw that the market broke below an important level of support, we immediately looked at the position of the Kumo cloud. The main goal is to profit from swings in price movement over the course of several days or weeks. The second signal was a buy signal, but the crossover happened below the 0-level. A conservative buy opportunity would be to wait for the CCI to cross above the 0-level. Ideally, we want a buy crossover above the 0 level and a sell crossover below the 0 level.

Using Bollinger Bands® To Gauge Trends

For my option trading I had built some volatility models in an early spreadsheet program called SuperCalc. One day I copied a volatility formula down a column of data and noticed that volatility was changing over time.

Bollinger Bands Indicator Guide

The indicator forms a channel around the price movements of an asset. The channels are based on standard deviations and a moving CAD to JPY average. Bollinger bands can help you establish a trend’s direction, spot potential reversals and monitor volatility.

How To Use The Bollinger Band Indicator

The stock breaks out once it surpasses the previous high in the W pattern, and the breakout is confirmed with a bullish signal line crossover in the MACD. Mr. Pines has traded on the NYSE, CBOE and Pacific Stock Exchange.

This special strategy teaches you how to read Bollinger Bands and Bollinger Band signals. You’ll also learn about Bollinger Bands squeeze, double Bollinger bands strategy, Bollinger Bands secrets, and more. W-Bottoms and M-Tops were part of Arthur Merrill’s work that identifies 16 patterns with a basic W-Pattern and M-Pattern, respectively. Bollinger Bands use W patterns to identify W-Bottoms when the second low is Bollinger Bands Indicator Guide lower than the first low but holds above the lower band. It occurs when a reaction low forms close to or below the lower band. The price then pulls back towards the middle band or higher and creates a new price low that holds the lower band. When the price moves above the high of the first pullback, the W-button is in place as shown in the figure below, and indicates that the price will likely rise to a new high.

Visualizing The Bollinger Bands®

However, when the volatility eventually returns to the market, there’s often a robust breakout from the bands. Then, the reaction pullback should take the price back inside the bands, ideally near or beyond the middle band . The implication of this is that the rally met with strong resistance and the price was pushed back to its normal level. This usually happens when the price breaks through the upper band. If the price does not break through the upper band, the move might not be that impulsive since it couldn’t extend into an extreme territory. On the other hand, instead of buying and selling when the market breaks the bands, you might wait until the market returns inside the bands and buy or sell somewhere near the middle band. You might find yourself in situations where, instead of reversing, the price is repeatedly pressing into the upper or lower band, indicating an extremely strong trend.

While technical analysis can identify things unseen on a ticker, it can also aid in our demise. Regardless of the trading platform, you will likely see a settings window like the following when configuring the indicator. For all you Audi driving, no foam latte traders, feel free to skip to Chapter 2. There is a famous saying that periods of unhappiness are always followed by periods of happiness and vice versa.

Why Did I Develop Bollinger Bands?

It’s time to take things one step further and dive into an exact trading strategy. According to Bollinger, the Squeeze setup is identified when the volatility reaches a six-month low value. If Bollinger Bands Indicator Guide you trade lower than the daily, you might translate this to a more relevant time period. Despite the best efforts, capitalizing on mean reversion can be challenging if the market is trending.

Many traders have developed systems that thrive on these bounces and this strategy is best used when the market is ranging and there is no clear trend. Of course, like any other indicator, you shouldn’t solely rely on the bands for any trade. You need to look at a variety of indicators and also perform detailed fundamental research.

Can Bollinger Bands Predict Huge Price Moves?

However, touches of the bands are just that, are not signals. A touch of the upper Bollinger Band is not a sell signal and a touch of the lower Bollinger Band does not represent a buy signal. On the other hand, a 2.5 standard deviation Bollinger Bands or even a 3 standard deviation will generate fewer trading signals, but high-probability signals. Almost 99% of the price action is contained within 3.0 standard deviation of the Bollinger Bands.

Bollinger Bands Indicator Guide

The price hogs the lower 2 SD/3 SD bands for 4 days/candles – finding support. Actually, holding the Ichimoku Kijun-Sen – again more on this in another article to come later. The price breaks out and rides the 2 SD and 3 SD upper bands for 7 days. It then reverses at the trend line/2 SD where it finds Bollinger Bands Indicator Guide resistance and drops to find support again at the middle band/Kijun- Sen. The above Dow mini 5 min chart clearly illustrates a squeezing of the Bollinger Bands and then a subsequent expansion and band ride. Actually, it is holding the Ichimoku Kijun-Sen – more on this in another article to come later.

Similarly in trading, periods of high volatility are always’! ’ followed by periods of less volatility and again by periods of high volatility. We have to always remember that trading is a game of probability, the more sure we can become about the move the more successful would be our chance at it. Bollinger Bands is one more tool I would recommend you to master and use in conjunction with the others. When the price is in a strong downtrend it will typically touch or run along the lower band during impulse waves lower. When it fails to do that it shows the downtrend may be losing momentum. When the price is in a strong uptrend it shouldn’t touch the lower band.

They are used in pairs, both upper and lower bands and in conjunction with a moving average. Further, the pair of bands is not intended to be used on its own. Use the pair to confirm signals given with other indicators.

Don’t skip ahead, but I will touch on this from my personal experience a little later in this article. You could argue that you don’t need the bands to execute this strategy. However, by having the bands, you can validate that a security is in a flat or low volatility phase, by reviewing the look and feel of the bands. In the above example, you just buy when a stock tests the low end of its range and the lower band. Conversely, you sell when the stock tests the high of the range and the upper band. You can then sell the position on a test of the upper band. If you have an appetite for risk, you can ride the bands to determine where to exit the position.

If the Bollinger band width suddenly starts becoming wider, it’s an indicator of the creation of a new trend. The markets are unstable and you should start preparing to enter into position.

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