Bollinger Bands is a sort of price envelope created by John Bollinger. These bands are price envelopes drawn at a standard deviation level above and below the simple moving average.
Envelopes define the upper and lower price levels. The bands respond to volatility fluctuations in the underlying price since their distance is based on standard deviation.
Standard deviation (SD) is used to quantify volatility, and it changes when volatility rises or falls. When there is a price increase, the bands broaden, and when there is a price fall, the bands narrow. Bollinger Bands can be used to trade various securities due to their dynamic nature.
Bollinger Bands are distinguished into three lines, i.e., Upper, Middle, and Lower bands.
- The Middle band is a MA, and the trader determines its settings.
- The upper and lower bands are on either side of the moving average band.
The trader determines how many SDs the volatility indicator should be set at. The distance between the middle, upper and lower bands is determined by the number of standard deviations.
The location of these bands indicates the strength of the trend and the potential high and low price levels to be predicted shortly.
How did Bollinger Bands work as Good Indicators?
- A significant price move in either direction increases when the bands narrow during a period of low volatility. This could be the trend that started. Keep an eye on the false moves oppositely that reverses before the true trend starts.
- Volatility rises when the bands diverge by an unusually high amount, and any existing trend may be ending.
- Prices tend to bounce around within the bands’ envelope, touching one band before moving on to the next. These swings can be used to help you discover potential profit objectives.
- During strong trends, the price might surpass the band envelope for extended periods of time. If your momentum oscillator shows divergence, you should do more study to see if taking additional profits is a good idea for you.
- A significant trend continuation is likely when the price breaks out of the bands. However, if prices instantly return to within the band, the implied strength is nullified.
Bollinger Band Uptrends
Bollinger Bands are used to see how strongly an asset is gaining and when it is likely to reverse or lose momentum. If an upswing is strong enough, it will consistently approach the upper band.
When an uptrend reaches the top band, it means the stock is moving higher, and traders can take advantage of the opportunity to buy and sell.
Price pulls back within uptrends, staying above the middle band and moving back to the top band, indicating a lot of strength.
Most technical traders hope to profit from strong uptrends before they reverse. When a stock fails to reach a new high, traders often sell it to prevent losing money due to a reversal of the trend.
Bollinger Band Downtrends
Bollinger Bands determine how far an item is falling and when it might be turning to the upside. The price will run along with the lower range in a severe decline, indicating that selling activity is still active.
Contrary, if the price fails to contact or move along the lower band, the downtrend may be losing steam. There is a lot of downtrend strength when there is price pullback (highs), and the price stays under the middle band and then moves back to the lower band.
The downtrend might last for a short or long time — minutes, hours, days, weeks, months, or even years. To protect their investments, investors must recognize any signs of a slump as soon as possible. If the lower bars show a consistent downtrend, traders should be wary about going into long bets that are likely unprofitable.
Bollinger Band W-Bottoms and M-Tops
W-Bottoms and M-Tops are two patterns with a fundamental W-Pattern and M-Pattern. When the second low is less than the first low but remains above the lower band, Bollinger Bands identify W-Bottoms. This happens when a low response forms at or below the lower band.
The price then pulls to the middle or upper band, forming a new price low that retains the lower band. The W-button is in position when the price climbs above the high of the first pullback, as shown in the chart below, and suggests that the price will likely increase to a new high.
Bollinger Bands’ Limitations
Although Bollinger Bands are useful tools for technical traders, they have several drawbacks that traders should be aware of before employing them. These are generally reactive, not predictive, which is one of its weaknesses.
The bands will react to changes in price, whether uptrends or downtrends, but they will not predict prices. Bollinger Bands, like the majority of technical indicators, are lagging indicators. This is the case because the tool is based on a simple moving average, which averages the prices of numerous price bars.
Another drawback of Bollinger Bands is that not all traders will benefit from the default settings. Traders must identify settings that enable them to define trading guidelines for individual equities. Traders can change the parameters or use a different tool if the selected band settings don’t work.
Conclusion
Bollinger bands are a useful tool for traders who want to profit from trend fatigue by identifying the price turn. However, counter-trend trading necessitates significantly higher margins of error, as trends frequently make multiple attempts to continue before reversing with trustworthy brokers like PrimeFin.
