What are Bollinger Bands?
Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. Having evolved from the concept of trading bands, Bollinger Bands can be used to measure the highness or lowness of the price relative to previous trades.
Bollinger Bands consist of:
• a middle band being an N-period simple moving average
• an upper band at K times an N-period standard deviation above the middle band
• a lower band at K times an N-period standard deviation below the middle band
Typical values for N and K are 20 and 2, respectively. The default choice for the average is a simple moving average, but other types of averages can be employed as needed. Exponential moving averages are a common second choice. Usually, the same period is used for both the middle band and the calculation of standard deviation.
What makes Bollinger bands do?
The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition prices are high at the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions.
How can we use the Bollinger Bands?
When the market is secure, there is less volatility in prices. On the other hand, if the market is insecure it reflects in a higher volatility of prices.
You can use the Bollinger Bands as a tool to find out the safest time to employ the trading signal. During a strong trend, prices will have a tendency to take a plunge to the mid band; this may be the best time to apply the trading signal.
The measure of how far the standard deviations of the outer bands have moved away from the average mean is an indication of how much the price has deviated from the normal value. Whenever you see the bands spread wide out from the mean value, you can take this as a sign to exit the market and lock-in and protect all the hard earned profits from getting wiped out by the instabilities in the market.
Whenever you see the bands spread wide out from the mean value, you can take this as a sign to exit the market and lock-in and protect all the hard earned profits from getting wiped out by the instabilities in the market.
You need to be extra careful whenever the bands are showing signs of a sudden increase in volatility, as a new trend can soon follow.
Do not depend solely on Bollinger bands for timing the market or to enter trading signals. Instead you can use it in combination with other methods like trend lines and momentum indicators.