Bollinger Bands

 What are Bollinger bands?

Bollinger Bands are a popular technical analysis tool used by traders and investors to analyze market volatility and identify potential price trends. They were developed by John Bollinger in the 1980s and are widely used in various financial markets, including stocks, commodities, and forex.

A Bollinger Band consists of three lines: the middle band, which is a simple moving average (SMA) of the price; and an upper band and a lower band, which are typically set two standard deviations away from the middle band. The standard deviation is a measure of volatility, and using two standard deviations creates a channel that contains approximately 95% of price data within it.

The main concept behind Bollinger Bands is that price tends to stay within the upper and lower bands most of the time, indicating periods of high and low volatility. When the price reaches the upper band, it is considered overbought, suggesting a potential reversal or pullback. Conversely, when the price reaches the lower band, it is considered oversold, indicating a potential reversal to the upside.

Traders often use Bollinger Bands in conjunction with other indicators or chart patterns to make trading decisions. For example, they may look for price breakouts outside the bands, which could signal a strong trend continuation. Additionally, the width of the bands can be used as an indicator of volatility. Narrow bands indicate low volatility, while wide bands suggest high volatility.

When using Bollinger Bands, it's important to remember that they are not foolproof and should be used in conjunction with other tools and analysis methods. Like any technical indicator, they have limitations and can generate false signals. Therefore, it's crucial to practice proper risk management and combine Bollinger Bands with other indicators or confirmatory signals.

How to trade with Bollinger Bands?

Bollinger Squeeze:     

A  trading strategy is to predict when a squeeze will begin. Using daily charts, the idea is that when the indicator reaches its lowest level in 6 months, volatility will rise. This relates to the tightening of the bands we mentioned earlier. The Bollinger Band indicator’s squeezing action frequently foreshadows a large move.

Additional indicators, such as volume expanding or the accumulation distribution indicator rising, can be used. These additional indicators add to the evidence of a possible Bollinger Band squeeze.

We need an advantage when trading a Bollinger Bands squeeze because these setups can fool even the most experienced traders.

Reversals

Fading stocks when they start printing outside of the bands is a simple but effective trading strategy. We’ll take it a step further and incorporate some candlestick analysis into this strategy.

For example, rather than shorting a stock as it approaches its upper band limit, wait to see how it performs. If the stock goes parabolic or gaps up and then closes near its low while trading near the outside of the bands, it is often a good indicator that the stock will correct in the near term.

Then, depending on where the stock finds support, you can enter a short position with three target exit areas: (1) the upper band, (2) the middle band, or (3) the lower band

Double Bottoms

A double-bottom setup is a common Bollinger Band strategy.

This formation’s first bottom is characterized by high volume and a sharp price pullback that closes outside of the lower Bollinger Band. These kinds of moves usually result in what is known as an “automatic rally.” The automatic rally’s high usually serves as the first level of resistance in the base-building process before the stock moves higher.

After the rally begins, the price attempts to retest the most recent lows in order to test the strength of the buying pressure that came in at that bottom.

This retest bar should print inside the lower band, according to many Bollinger Band technicians. This indicates that the stock’s downward pressure has subsided and that there is a shift from sellers to buyers. Pay close attention to the volume as well; it should drop dramatically.

 Riding the Bands

Many Bollinger Band newcomers make the same mistake: they sell when the price reaches the upper band and buy when it reaches the lower band. According to Bollinger, a touch of the upper or lower band does not constitute a buy or sell signal.

Look at the example below and notice how the bands tighten just before the breakout. To return to an earlier point, the price penetration of the bands cannot be used to justify shorting or selling a stock.

Take note of how the volume exploded on the breakout and the price began to trend outside of the bands; these can be extremely profitable setups if given enough room to fly.

Middle Bands 

The middle band is configured in many charting applications as a 20-period simple moving average.

When the stock is riding the bands, the middle line can represent areas of support on pullbacks. When the price returns to the middle line, you could increase your stock position.

In terms of determining when a trend is losing steam, the failure of the stock to continue to accelerate outside of the bands indicates a weakening in the stock’s strength. This is a good time to consider quitting or leaving a position entirely.