How to use Bollinger Bands
When RSI is near an extreme high (~100) or low (~0), and is touching either the high part of the upper band or the low part of the lower band, the RSI line could pull back sharply from the band. Bollinger Band analysis holds that a failure of RSI to touch the upper band on a second try generates a sell signal. At extreme lows, a failure of RSI to reach the lower band triggers a buy signal.
While some indicators or chart patterns only show a single trade set-up, Bollinger bands are quite flexible, and there are several ways to use the information that they provide to trade successfully. We are going to look at the three most common uses of Bollinger Bands when trading, and also explain how you can make successful trades by following these strategies. The two bands move with the simple moving average of price, and the gap between the upper and lower Bollinger band widens or narrows as volatility grows or shrinks. When the price level closes above the upper band, it is a positive volatility breakout. And likewise, a downside close below the lower Bollinger Band gives a negative volatility breakout.
In the 2001 chart of Microsoft below, you can see the trend reversed to an uptrend in the early part of January. Before the price action crossed over the centerline, the stock price moved from $20 to $24 and then on to between $24 and $25 before some traders would have confirmation of this trend reversal. Upper resistance and lower support lines are first drawn and then extrapolated to form channels within which the trader expects prices to be contained. As long as prices do not move out of this channel, the trader can be reasonably confident that prices are moving as expected.
However, Bollinger Bands—especially when paired with other indicators such as chart pattern recognition tools—can help you make better trading decisions. If the upper and lower bands are 1 standard deviation, this means that about 68% of price moves that have occurred recently are CONTAINED within these bands. Most charting programs default to a 20-period, which is fine for most traders, but you can experiment with different moving average lengths after you get a little experience applying Bollinger Bands.
When considering which stocks to buy or sell, you should use the approach that you’re most comfortable with. How can Bollinger Bands help you determine the relative strength of a stock? John Bollinger, who created this indicator, considers the price of the stock relatively low if it is near the lower band, and relatively high if it’s near the upper band.
If you’re looking to go long when trading a squeeze, consider placing a buy entry point above the upper band. Once it’s executed, you could place an initial stop under the low of the breakout formation or under the lower band. 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). If the upper and lower bands are 2 standard deviations, this means that about 95% of price moves that have occurred recently are CONTAINED within these bands.
- In addition, traders can select the entry and exit points by evaluating the price channel created by the bands capturing the price fluctuations.
- When the BBs expand, the bandwidth increases and decreases when the BBs contract or direct towards each other.
- When using Bollinger Bands®, designate the upper and lower bands as price targets.
- John Bollinger who developed this method has always mentioned that these methods were designed to be used with other indicators and methods.
- It involves the use of three bands—one for the upper level, another for the lower level, and the third for the moving average.
This way, these bands can capture at least 85% of the price data moving between them for that period. The same thing happens when an asset price is in an uptrend; the Bollinger Bands lag behind. However, as the price approaches and breaks the upper Bollinger Band, the underlying asset becomes “expensive.” That’s because, at the x2 standard deviation, the price moves too far above the SMA. This may be a good opportunity to sell the asset (i.e., place short positions) and is generally not a good time to buy.
How to Calculate Bollinger Bands
If the prices breach the lower trend and the next 2-3 candles confirm the move in the downward direction then we can say that the trend is downtrend. The main three components are the middle, upper, and lower bands. The upper and lower bands are based on standard deviations, and an N Day Moving Average forms the middle band. Exponential https://1investing.in/ Bollinger Bands eliminate sudden changes in the width of the bands caused by large price changes exiting the back of the calculation window. Exponential averages must be used for BOTH the middle band and in the calculation of standard deviation. 12.Traditional Bollinger Bands are based upon a simple moving average.
Bollinger bands help assess how strongly an asset is rising , and when the asset is potentially losing strength or reversing. This information can then be used to help make trading decisions. Here are three guidelines for using Bollinger bands in an uptrend. However, they have their drawbacks and should be used in conjunction with other indicators so as to maximize their effectiveness. We have mentioned how the standard Bollinger Band uses a 20-days SMA and 2 standard deviations. For example, a more active trader may want to utilize a Bollinger Band which deviates less and/or utilizes a lesser number of periods .
When the Bollinger bands expand, it indicates that the volatility has increased in the stock or index. Similarly when the Bollinger Bands contracts, it indicates that the volatility has reduced in the stock or index. Expansion beginning investors with small amounts to invest should and contraction of Bollinger bands are cyclic in nature. By definition price is high at the upper band and low at the lower band. If you are Forex trading, remember that not every currency pair has enough volatility.
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In this instance, the price registers two high tops close to or sometimes even above the upper Bollinger Band. Then the price sharply pulls back to form an “M” pattern on the chart. This strategy looks to identify signs of lower resistance level testing that usually happens before a sharp price rally. There are two bottoms to look for — the first should stop below the lower band and occur when there is high volume, while the second represents a resistance test on a lower volume. Hypothetically, if you were trading the above chart, then you’d simply identify the correct breakout point, take a long position, and ride out the resulting price rise.
Setups like these don’t occur every day, but you can probably spot them a few times a week if you are looking at a 15-minute chart. One thing you should know about Bollinger Bands is that theprice tends to return to the middle of the bands. So, the more tools you have, the better you can ADAPT to the ever-changing market environment. Find the approximate amount of currency units to buy or sell so you can control your maximum risk per position.
A professional trader considers many things before making the simplest decision on a trade because the least decision could be a success or misfortune. Statistical charts are not limited to school activities; they are also used in trading. In fact, John Bollinger used statistics to figure out the relationship between lows and highs, called the Bollinger bands.
Therefore, the bands naturally widen and narrow in sync with price action, creating a very accurate trending envelope. Bollinger Bands® are a trading tool used to determine entry and exit points for a trade. Bollinger Bands can also provide a unique assessment of volatility.
For breakouts downwards through the support levels, that is the Lower Bollinger Band, the entry signal to sell the market is a candle with a lower low and a lower close than the signal candle. When it comes to technical trading, few people have an impact big enough for their name to become part of the lexicon of the industry, but John Bollinger is one such person. A long-time market technician, John Bollinger started looking at new ways of determining trading bands, that is areas of support and resistance, through adaptation of moving averages in the early 1980s.
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The lower band is an oversold zone which gives value buying, while the upper band tells you the target buying. When the stock or index hits the lower band, it creates a buying opportunity. A good buyer tries to accumulate stock for the long-term, hence, doing it on dips.
For example, while in the graph of the Tesla Bollinger bands, you will see that the price took a nosedive, which was due to the news that SEC had sued Elon Musk over false news. Even though the indicator has many advantages and is easy to use, you should not rely on it alone. This signal is strengthened by a second top or bottom being made inside the bands. This signal reflects the market has made a strong run , and as part of a blowout, an extreme move is often seen before the market begins to retrace. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Leveraged trading in foreign currency or off-exchange products on margin carries significant risk and may not be suitable for all investors.
How to calculate Bollinger bands
This is the industry standard that can be modified according to your liking. Since Bollinger Bands consist of 3 different plotted lines, here is how you can calculate each of those bands. A good idea is to pair it with other indicators such as MACD or RSI to make a better trade decision. One must understand that the reversal of the price trend can happen due to a variety of factors, not least because of the bands themselves. The following are a few trading strategies which can be used keeping the Bollinger bands at the centre of it all. An M-Top happens when a response moves near or over the upper band.
If you are new to the concept of Bollinger Bands, you do not need to divulge into these variations. Instead, simply use the formulas mentioned above to calculate the bands and then interpret them for your analysis. The limitation of Bollinger Bands is that they are computed using a 20-day Moving Average, meaning that they weigh all data points as the same. Thus, a recent event is not given more weightage and can impair the indicator’s ability to correctly observe a trend. It is at this precise moment where most traders are confident that the price will increase and sustain itself.
This squeeze is often followed by periods of high volatility, and may bring about a noteworthy move by the stock to the upside or the downside. The bands expand and contract as the price action of an issue becomes volatile or becomes bound into a tight trading pattern . When the price continually touches the upper Bollinger Band, it can indicate an overbought signal while continually touching the lower band indicates an oversold signal.