Bollinger Bands® Understanding How Bollinger Bands Work

bollinger bands

The authors did, however, find that a simple reversal of the strategy («contrarian Bollinger Band») produced positive returns in a variety of markets. The fact that the second high is within the upper band suggests that it is a lower high on a relative basis. Flexible and visually intuitive to many traders, Bollinger Bands® can be a helpful technical analysis tool. Invented in 1983 by John Bollinger, they’re designed to help traders evaluate price action and a stock’s volatility.

Remember to adjust your stop orders as needed, or consider using a trailing stop designated in either a fixed dollar amount or a fixed percentage. Another method would be to use the parabolic SAR indicator to trail your stop. Finally, to capture longer moves, you could consider exiting when the stock tags the opposite band (i.e., the lower band if you’re long, or the upper band if you’re short). Next, calculate the standard deviation over the same number of periods as the simple moving average. For the upper band, add the standard deviation to the moving average. For the lower band, subtract the standard deviation from the moving average.

Market Timing

Developed by John Bollinger, bollinger bands® are volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes as volatility increases and decreases. The bands automatically widen when volatility increases and contract when volatility decreases. Their dynamic nature allows them to be used on different securities with the standard settings. Using the default parameters of a 20-period look back and plus/minus two standard deviations, bandwidth is equal to four times the 20-period coefficient of variation. To identify a double bottom, look for a price that has touched the lower band and wait to see where the next low occurs.

Double tops, head-and-shoulders patterns, and diamonds represent evolving tops. John Bollinger developed Bollinger Bands in the early 1980s and since their introduction 30 years ago they have become one of the most widely used technical indicators worldwide. BBImpulse measures price change as a function of the bands; percent bandwidth (%b) normalizes the width of the bands over time; and bandwidth delta quantifies the changing width of the bands. Schwab does not recommend the use of technical analysis as a sole means of investment research. Technical analysis is a trading strategy that analyzes statistical trends to identify trading opportunities. Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA.

The Squeeze

Bollinger suggests increasing the standard deviation multiplier to 2.1 for a 50-period SMA and decreasing the standard deviation multiplier to 1.9 for a 10-period SMA. Many traders believe the closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. John Bollinger has a set of 22 rules to follow when using the bands as a trading system. The first step in calculating Bollinger Bands® is to compute the simple moving average (SMA) of the security, typically using a 20-day SMA. A 20-day SMA averages the closing prices for the first 20 days as the first data point.

  • Therefore, a protection needs to be in place once the decision to buy has been made.
  • The middle band is a moving average, and its parameters are chosen by the trader.
  • An upper band touch that occurs after a Bollinger Band confirmed W-Bottom would signal the start of an uptrend.
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  • It has been found that buying the breaks of the lower Bollinger Band® is a way to take advantage of oversold conditions.

Bollinger Bands® are often used along with the relative strength indicator (RSI) as well as the BandWidth indicator, which is the measure of the width of the bands relative to the middle band. One technical indicator—Bollinger Bands—suggests that US stocks, broadly speaking, may be overbought on a short-term basis. However, traders should remember that Bollinger Bands are based on historical information. Therefore, the bands can only react to price movements but not predict future price movements. As with most other technical analysis tools, Bollinger Bands, too, come with its own set of unique advantages and disadvantages.

Scanning for Bollinger Bands

If the candles start to break out above the TOP band, then the move will usually continue to go UP. One technical indicator is not better than the other; it is a personal choice based on which works best for the strategies being employed.® and Keltner Channels are different, but similar, indicators. Here is a brief look at the differences, so you can decide which one you like better. Perhaps a more useful way to trade with Bollinger Bands® is to use them to gauge trends.

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