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The Basics of Bollinger Bands®

The Basics of Bollinger Bands®

Forex Trading Comments Off on The Basics of Bollinger Bands®

Unlike a percentage calculation from a normal moving average, Bollinger Bands® simply add and subtract a standard deviation calculation. 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 fxcm scam 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. Instead, it is sometimes wise to measure the width of the “no man’s land” area (distance between +1 and –1 SD) and add it to the upper band.

When plotted automatically by a trading platform, Bollinger bands are very user-friendly and can add another dimension to chart analysis for a trader. Especially when combined with other confluence factors such as higher timeframe support and resistance levels and other exhaustion signals. As the name implies, Bollinger Bands® are price channels (bands) that are plotted above and below the price action. Note how, in the following chart, the trader is able to stay with the move for most of the uptrend, exiting only when price starts to consolidate at the top of the new range.

Created by John Bollinger in the 1980s, the bands offer unique insights into price and volatility. In fact, there are a number of uses for Bollinger Bands®, such as determining overbought and oversold levels, as a trend following tool, and for monitoring for breakouts. As with a simple moving average, Bollinger Bands should be shown on top of a price plot. 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.

Strong trends, especially those developing after a breakout of a trading range, will result in an expansion in volatility that will cause the bands to initially move apart. This means that in a strong uptrend, bitfinex review the lower band will actually move downward in the opposite direction of the new trend. When the lower band turns back up, it can be a signal that the move higher might be over, at least for a while.

  1. Bollinger Bands® was developed by technical trader John Bollinger and designed to give investors a higher probability of identifying when an asset is oversold or overbought.
  2. Note, however, that counter-trend trading requires far larger margins of error, as trends will often make several attempts at continuation before reversing.
  3. In this section, we will explore how Bollinger Bands show market volatility and understand the distance between the bands and price action.
  4. One technical indicator—Bollinger Bands—suggests investors may be feeling uncertain about US stocks over the short term.
  5. Instead, it is sometimes wise to measure the width of the “no man’s land” area (distance between +1 and –1 SD) and add it to the upper band.

Next, multiply that standard deviation value by two and both add and subtract that amount from each point along the SMA. In simple terms, we would say that 95% of all the price action happens in between the Bollinger Bands®. A move outside of the outer Bollinger Bands ® shows a significant price move city index review and is a 5% outlier. Again, I do not want to get too technical, but a small excursion is important to understand the approach of the Bollinger Bands® indicator and why it is so powerful. Members can also set up alerts to notify them when a Bollinger Bands-based signal is triggered for a stock.

How this indicator works

In the chart below, we see that a fade-trader using Bollinger Band® “bands” will be able to quickly diagnose the first hint of trend weakness. Having seen prices fall out of the trend channel, the fader may decide to make classic use of Bollinger Bands® by shorting the next tag of the upper Bollinger Band®. To help remedy this, a trader can look at the overall direction of price and then only take trade signals that align the trader with the trend. For example, if the trend is down, only take short positions when the upper band is tagged. 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.

How To Calculate Bollinger Bands

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Leveraged trading in foreign currency or off-exchange products on margin carries significant risk and may not be suitable for all investors.

Should You Trust Popular Trading Proverbs?

Using the bands as overbought/oversold indicators relies on the concept of mean reversion of the price. Mean reversion assumes that, if the price deviates substantially from the mean or average, it eventually reverts back to the mean price. Short selling is an advanced trading strategy involving potentially unlimited risks and must be done in a margin account. For more information, please refer to your account agreement and the Margin Risk Disclosure Statement. To identify a double bottom, look for a price that has touched the lower band and wait to see where the next low occurs. A price that reacts and rises close to the middle band, followed by a second low inside the lower band, suggests that the price is positioned for an upward move—a good time for traders to buy.

Schwab does not recommend the use of technical analysis as a sole means of investment research. It’s worth noting that Bollinger believes a close either above the band or below the band is not necessarily a reversal signal, but rather a continuation pattern. It’s been an up and down start to 2024 for US stocks thus far (the S&P 500 is flat more than halfway through January), as markets have struggled to maintain last year’s momentum. Mostly positive company results in the early goings of this earnings season have bumped up against overly aggressive expectations for rate cuts, stubborn prices for some goods, and global conflicts. Therefore, it should be considered only in combination with the readings of other indicators.

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Perhaps a more useful way to trade with Bollinger Bands® is to use them to gauge trends. This scan finds stocks that have just moved below their lower Bollinger Band line. This scan finds stocks that have just moved above their upper Bollinger Band line.

These parameters can be adjusted to meet your technical analysis needs. The middle band is a simple moving average that is usually set at 20 periods. A simple moving average is used because the standard deviation formula also uses a simple moving average. The look-back period for the standard deviation is the same as for the simple moving average.

Similarly, when the price approaches the lower band, it may struggle to go lower and may also reverse direction. The moving average, representing the average price of a security over a pre-determined number of time periods, serves as the base for the calculation of the upper and lower bands. The Bollinger Bands, one of the most widely used technical indicators in technical analysis, has three components – a moving average, an upper band, and a lower band. Technical analysis focuses on market action — specifically, volume and price.

Technical traders monitor the behavior of an uptrend to know when it shows strength or weakness, and they use this as an indication of a possible trend reversal. Such techniques usually require the sample to be independent and identically distributed, which is not the case for a time series like security prices. Various studies of the effectiveness of the Bollinger Band strategy have been performed with mixed results. The authors did, however, find that a simple reversal of the strategy (“contrarian Bollinger Band”) produced positive returns in a variety of markets. The chart thus expresses arbitrary choices or assumptions of the user, and is not strictly about the price data alone.