Content
Now, the Bollinger Bands ® started narrowing and the price even reached the higher Bollinger Bands ®. The reaction around the higher band can tell us a lot about the market behavior. In this example, the market just briefly poked indicator tools for trading above the higher Bollinger Bands ® and then immediately was rejected.
Trend-Trading with the Bollinger Bands ®
A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. The articles and research support materials available on this https://www.xcritical.com/ site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
What is the approximate value of your cash savings and other investments?
Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they Bitcoin are provided to our clients. The highs and lows of a consolidation may be marked with trend lines. A price moves above the high of the consolidation would consider an upside breakout, while a price close below the low of the consolidation would consider a downside breakout.
Interpretation of Bollinger Bands
The lower band can still be used as an exit if desired, but a new long position is not opened since that would mean going against the trend. You can obtain this data from various sources, such as Yahoo Finance or a financial data provider. Ensure the data includes at least the date, open, high, low, and close prices. One strategy effective for the relatively low-risk individual who is content with low but safe returns on their investment is to trade by keeping the SMA as the signal to enter or exit the trade. Since the SMA is essentially an average and the price keeps swinging from one side of the SMA to the other, you are bound to end up with a profit.
- The Bollinger Bands Breakout strategy is used when the price of an asset breaks through the upper or lower band.
- A Bollinger Band squeeze can lead to a breakout, but it doesn’t specify the direction of the breakout.
- Traders should adjust the parameters (e.g., the moving average period and standard deviation multiplier) to better suit the asset and trading style they are using.
- With a standard deviation of 2, we would say that 95% of all observed price points should fall within the Bollinger Bands®.
- The Bollinger Band® indicator is not a lagging indicator because it adjusts to price action in real-time and the indicator uses the price volatility to adjust to the current price behavior.
- After a pullback below the 20-day SMA (middle Bollinger Band), the stock moved to a higher high above 17.
Given that the bands are plotted two standard deviations away from the SMA, they can indicate when prices are statistically high or low. Many traders consider the area near the upper band to be overbought territory—the price is poised to fall—and a potential resistance level where sellers may step in. Conversely, the area near the lower band is often seen as oversold—the price is poised to go up—and a potential support level where buyers could enter the market. Chart 6 shows Air Products (APD) with a surge and close above the upper band in mid-July. First, notice that this is a strong surge that broke above two resistance levels. The Bollinger Bands narrowed, but APD did not close below the lower band.
Bollinger Bands® are highly technical tools that give traders an idea of where the market is moving based on prices. It involves the use of three bands—one for the upper level, another for the lower level, and the third for the moving average. When prices move closer to the upper band, it indicates that the market may be overbought. Conversely, the market may be oversold when prices end up moving closer to the lower or bottom band. A stock may trade for long periods in a trend, albeit with some volatility from time to time.
Even though the 5-Feb spike low broke the lower band, the signal is not affected since, like Bollinger Bands, it is calculated using closing prices. Fourth, the stock surged with expanding volume in late February and broke above the early February high. Technical analysis is a trading strategy that analyzes statistical trends to identify trading opportunities. Another strategy is called the “Bollinger Bounce.” This is based on the idea that prices tend to return to the middle band. Traders may buy or sell based on the rebound from the upper or lower bands toward the middle band, especially in a ranging market.
One day I copied a volatility formula down a column of data and noticed that volatility was changing over time. That was not intuitively correct at the time, as volatility was viewed as a static quantity, a property of a security. When an asset is trending and going into a clear direction the SMA should be pointing towards that direction in a clearly visible manner. The whole point of Bollinger Bands is to track how far away the prices are from the average (SMA) and within the limits set by the standard deviation in order to understand if something is expensive or cheap. Remember that we’re using 2 as our multiplier, if you changed the multiplier to 3, or 4, that means you’re using that number of standard deviations and the bands would become wider. Finally, the Bollinger Bands ® started contracting and the bands narrowed when the price started moving sideways with smaller candlesticks.
Relying only on Bollinger Bands without further confirmation can lead to poor trading decisions. Bollinger Bands is a versatile technical analysis tool that can provide greater clarity about market volatility and price trends. While it’s valuable for highlighting potential reversals, breakouts, and trend strengths, Bollinger Bands is usually more effective when used with other indicators and methods.
Additionally, the MACD formed a bearish divergence and moved below its signal line for confirmation. W-Bottoms were part of Arthur Merrill’s work that identified 16 patterns with a basic W shape. Bollinger uses these various W patterns with Bollinger Bands to identify W-Bottoms, which form in a downtrends and contain two reaction lows. In particular, Bollinger looks for W-Bottoms where the second low is lower than the first but holds above the lower band. The ability to hold above the lower band on the test shows less weakness on the last decline.
However, traders should also be aware of the limitations of the tool and should use other technical analysis tools to confirm signals and make informed trading decisions. Traders should use other technical analysis tools, such as volume indicators and oscillators, to confirm signals and make informed trading decisions. Bollinger Bands reflect direction with the 20-period SMA and volatility with the upper/lower bands. According to Bollinger, the bands should contain 88-89% of price action, which makes a move outside the bands significant. Technically, prices are relatively high when they’re above the upper band and relatively low when below the lower band.
Upon selecting Bollinger Bands, the default setting will appear in the parameters window (20,2). The first number (20) sets the periods for the simple moving average and the standard deviation. The second number (2) sets the standard deviation multiplier for the upper and lower bands. These default parameters set the bands 2 standard deviations above/below the simple moving average. A Bollinger Band overlay can be set at (50,2.1) for a longer timeframe or at (10,1.9) for a shorter timeframe.
So the formula above is telling us to add all the values of our periods and divide it by the amount of periods we’ll use. We are starting with the Bollinger Bands ® contraction because a contraction often foreshadows a trend change or a trend continuation and is, therefore, the first important signal. Bollinger Bands ® do not lag (as much) because they always change automatically with the price action.
Because they are tools, not a system, and because BB applications are so diverse, they continue to work year after year as they are adapted and applied in new ways. Bollinger Bands work best when the middle band is chosen to reflect the intermediate-term trend, so that trend information is effectively combined with relative price level information. When I started working in the markets percentage bands were the most popular choice.
