Bollinger Bands consist of a moving average and two trading bands. The latter are the result of adding subtracting a standard deviation to from a normal moving average. In statistics, the standard deviation is a measure that is used to qualify the amount of variation. In technical analysis, the standard deviation SD is used to estimate price volatility of an asset. In other words, the higher the standard deviation the wider the price range of an underlying asset for the given period of time.
Measuring how far the price can deviate from its average value is helpful when one wants to predict future price fluctuations. As noted above, the indicator consists of three lines: Price channels depend on price action, widening at the moments of high volatility and contracting when the market is still.
Price bands are the standard deviations of the underlying asset and encompass the trading activity around the trend. For investors volatility is as important as trend direction and trend strength: Periods of low volatility are usually followed by serious market movements, which can also be predicted with the help of Bollinger Bands. All of the above can be used by traders to determine optimal entry points. As a rule, periods of low volatility are generally intermingled with high volatility periods.
In the downtrend, the price usually fluctuates between the lower band and the average line. In the uptrend, on the contrary, the price lies in the corridor between the upper band and the middle line. The longer the market stays still the higher are the chances for an upcoming volatility boost. Bollinger Bands are ideally suited to pinpoint such moments. The situation when the price bands come closer together is called the squeeze. Such periods indicate low current volatility and potential for high volatility in the near future.
Traders remain mostly inactive during the squeeze. They should not be used as trading signals as they do not provide any information on future trend strength and direction. Bollinger Bands are good at showing current volatility and sometimes predicting upcoming market fluctuations but are not a universal trading tool. Bollinger himself, this indicator should be combined with other indicators for maximum predictive potential and effectiveness. Bollinger Bands are an indicator worth learning and using in real-life trading.
Not only it is simple and useful but also has a potential of giving the trader timely buy or sell signals, while the majority of market participants are still unaware of the future trend direction. Buying the stock when the average line crosses below the lower Bollinger Band and selling it when the price has bounced from the upper Bollinger line is a widely used trading strategy with high profit-generating potential.
This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future. The financial services provided by this website carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.
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