Bollinger Bands are a volatility based indicator, developed by John Bollinger, which have a number of trading applications.
There are three lines that compose Bollinger Bands: A simple moving average (middle band) and an upper and lower band. These bands move with the price, widening or narrowing as volatility increases or decreases, respectively. The position of the bands and how the price acts in relation to the bands provides information about how strong the trend is and potential bottom or topping signals.
Bollinger Bands are used on all time frames, such as daily, hourly or five-minute charts. Bollinger Bands have two adjustable settings: the Period and the Standard Deviation. The Period is how many price bars are included in the Bollinger Band calculation. The number of periods used is often 20, but is adjusted to suit various trading styles.
2. what is consists of ? :
The Standard Deviation is typically set at 2.0, and determines the widths of the Bands. The higher the Standard Deviation, the harder it will be for the price to reach the upper or lower band. The lower the Standard Deviation the easier it is for price to “breakout” of the Bands.
Bollinger Bands denoted (20,2) means the Period and Standard Deviation are set to 20 and 2, respectively.
The indicator is calculated using the following formula. First calculate the Middle Band, then calculate the Upper and Lower Bands.
ú Middle Band = 20-day simple moving average (SMA)
ú Upper Band = 20-day SMA + (20-day standard deviation of price x 2)
ú Lower Band = 20-day SMA – (20-day standard deviation of price x 2)
Where SMA = the sum of closing prices over n periods / by n.
3. Trading with Bollinger Bands :
The first way to use Bollinger Bands is for analysis. Some common occurrences provide us with information on the direction and strength of the trend. This information can then be used to confirm trade signals from other indicators or strategies to make trades.
- If an uptrend is strong it will reach the upper band on a regular basis. Reaching the upper band shows the stock is pushing higher and buying activity remains strong.
- When the price pulls back, within the uptrend, if it stays above the middle band and then moves back to upper band it shows a lot of strength.
- During an uptrend the price shouldn’t break below the lower band; if it does it warns the uptrend has slowed and may be reversing.
- If a downtrend is strong it will reach the lower band on a regular basis. Reaching the lower band shows selling activity remains strong.
- ú When the price pulls back (higher), within the downtrend, if it stays below the middle band and then moves back to lower band it shows a lot of strength.
- ú During a downtrend the price shouldn’t break above the upper band; if it does it warns the uptrend has slowed and may be reversing.
This tool tells us whether the market is quiet or whether the market is LOUD!
When the market is quiet, the bands contract and when the market is LOUD, the bands expand.
- A. A move that originates at one band tends to go all the way to the other band, setting therefore an indicative price target.
- B. When volatility lessens and the bands tighten (come together), it is usually a sign that a significant market move will result in one or the other direction.
- C. When volatility increases and the bands are unusually far apart while at the same time there is evidence of a top/bottom formation, it is often a sign that the market has moved too far and that the current trend is ending.
- D. When prices move outside the bands, it implies a continuation of the current trend.
- E. Bottoms and tops formed outside the bands followed by a failure to achieve the same extreme twice and re-entering the bands call for possible reversals in trend
5- Conclusion :
The Bollinger bands are a great indicator to use in any market. When you combine these with other indicators that confirm the decision for enter markets . This little tips can conclude this wonderful tool :
- The Bollinger Bands indicator can help you identify when the market is “cheap” or “expensive” .
- In an uptrend, you can long near the lower Bollinger Band .
- In a downtrend, you can short near the upper Bollinger Band .
- When the Bollinger Bands is in a squeeze, it signals the market is “ready” to breakout .