In contrast, day traders and swing traders may use a lower number of periods and lower standard deviation. For this reason, the Bollinger Bands indicator is best utilized in conjunction with other indicators and technical analysis tools as part of a comprehensive trading strategy. To use this strategy, traders look for price action patterns, such as candlestick patterns or momentum indicators, to signal a potential reversal. For example, when the price reaches the upper band, and a bearish candlestick pattern forms, traders can enter a short position, expecting the price to revert to the moving average.

price touches

The earliest example of trading bands that I have been able to uncover comes from Wilfrid Ledoux in 1960. He used curves connecting the monthly highs and lows of the Dow Jones Industrial Average as a long-term market-timing tool. After Ledoux the exact sequence of trading band development gets foggy. In 1960 Chester Keltner proposed a trading system, The 10-Day Moving Average Rule, which later became Keltner bands in the hands of market technicians whose names we do not know. M. Hurst who used cycles to draw envelopes around the price structure.

Day Trading Strategy – Bollinger Band + MACD

Once the signal line of the Stochastic indicator falls below 80, you can place an order. The best way to find the exit point is to wait until the price reaches the opposite band of the BB indicator. If you look closely at the screenshot we have posted above you can see that there is a hammer signal indicating that the price is likely to start growing. You can use the price action trading system to minimize the number of fake signals.

It signals a trade but then moves back in the other direction, resulting in a losing trade. Chart 2 shows Nordstrom with a W-Bottom in January-February 2010. First, the stock formed a reaction low in January and broke below the lower band.

Conversely, the wider apart the bands move, the more likely the chance of a decrease in volatility and the greater the possibility of exiting a trade. The bands do not indicate when the change may take place or in which direction the price could move. Similarly, a trader might sell when price breaks below the lower Bollinger Band. A trader might use other confirming indicators as well, such as a support line being broken, as shown in Chart 3 above of Wal-Mart stock breaking below support. Thus, the price should not last and should “revert back to the mean.” This generally means the 20-period simple moving average.

Because of this, reading the Bollinger Bands doesn’t provide too much trend analysis insight during sideways price action. Once volatility increases, the lines, and price start moving again, which can help with trend analysis again. On the other hand, bounces are based on the premise that price tends to get drawn towards the average. Since the upper and lower bands essentially become our support and resistance levels, it’s not so hard to predict the next possible price move. This concept is the basis for the “overbought” and “oversold” strategies.

Moving Average in Bollinger Bands

Bollinger Bands® are a popular technical analysis​ tool that indicates whether an instrument’s price is high or low on a relative basis. Invented by John Bollinger in the 1980s, Bollinger Bands can be applied to a variety of different financial instruments. So from knowing how the bollinger band is calculated, you can say that the more distant the upper and lower bollinger bands are from each other, the higher the volatility of the market.

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The upper band represents a potential overbought level, while the lower band represents a potential oversold level. When a security’s price approaches the upper band, it may be a sign that the security is overbought and due for a correction. Conversely, when a security’s price approaches the lower band, it may be a sign that the security is oversold and due for a reversal.

Best Uses Of Bollinger Bands For Trading Setups

When the price moves above the high of the first pullback, the W-button is in place as shown in the figure below, and indicates that the price will likely rise to a new high. Asktraders is a free website that is supported by our advertising partners. As such we may earn a commision when you make a purchase after following a link from our website.

Volatility in stock market keeps on changing but as we know BB are best to gauge the volatility in stocks, so it is advisable to use this strategy. After reading till now, you might be thinking, OK that’s great so i can just go long when the price reaches the lower band and when the prices reaches upper just need to start selling. For this example, I have to go with the Keltner Channel, because I will always go with outside of the bands versus riding the bands in terms of strength of trend. Just a side note, assuming you are day trading, then the major gap down the next day would not apply because you would have closed your position.

  • The upper band represents a potential overbought level, while the lower band represents a potential oversold level.
  • In general, during strong trends, price action usually stays close to the outer band.
  • Traders use Bollinger Bands to identify when a security is overbought or oversold, which can help them to determine potential price reversals or corrections.
  • A Bollinger Band overlay can be set at (50,2.1) for a longer timeframe or at (10,1.9) for a shorter timeframe.
  • By carefully analyzing all three bands and the rate of contraction or widening between them, you have a better chance of predicting ideal market entry and exit points.

While I won’t be going too deep into the concept of bands, I will try to provide a basic understanding of what they are. Bollinger bands are a type of technical indicator that allows traders to analyze the volatility of a stock and whether the price is high or low on a relative basis. The top band is typically two standard deviations above the SMA and the bottom band is typically two standard deviations below the SMA.

Getting a clear signal with Bollinger Bands

The figure shows a squeeze where the Bollinger Bands contract, signaling a low volatility cycle, after which traders look for a breakout of the narrow range of trading. \nThe figure shows a squeeze where the Bollinger Bands contract, signaling a low volatility cycle, after which traders look for a breakout of the narrow range of trading. The idea behind this indicator is that when it hits a six-month low, traders can expect volatility to increase. At this point in time, a squeeze is triggered and the instrument’s price may move significantly. The best thing about trading chart breakouts is that trends start with breakouts.


Now as we look over at the Bollinger Band example, the stock was still nicely sitting inside of the bands, albeit riding the bands. Again, if you are looking for more technical articles on the two indicators, there are tons of posts on the web. I figured I would just stick to the comparison and leave the number-crunching up to the mathematicians.

To obtain the volatility component – which Bollinger bands %B doesn’t capture – one would either have to rely on the standard Bollinger bands, or use Bollinger BandWidth. Bollinger bands can also represent a clear visual of current volatility in the market, with contracted bands denoting low volatility and wide bands denoting high volatility . As one can see, the signals, based on candles leaving the bands, are few and far between. Bollinger Bands can be used in pattern recognition to define/clarify pure price patterns such as “M” tops and “W” bottoms, momentum shifts, etc.

Along the way we got another fine example of envelopes, Donchian, which consist of the highest high and lowest low of the immediately prior n-days. Over the years there have been many variations on those ideas, some of which are still in use. Today the most popular approaches to trading bands are Donchian, Keltner, Percentage and, of course, Bollinger Bands. The stock broke down in January with a support break and closed below the lower band.

You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. This might help reduce losses when prices break out of the Bollinger Bands for a while. Many profitable opportunities could be lost in this case, of course. Incase you are looking for any Personal loan or want to calculate the monthly EMI, than do check moneycontain free personal loan calculator.

After prices have rested, such as periods when the Bollinger Bands are extremely close together, then prices may begin to move once again. This is best suited for intraday trade setup seeing such candles at the top. The stock started falling again once it breached the median 20 day line, with strong bearish marubozu candle. RSI bearish divergence forms when the price forms a higher high, and at the same time the RSI decreases, and forms a lower high. You will usually see RSI divergence forming at the top of the bullish market, and this is known as a reversal pattern.

I likewise take a look at the Bollinger Bands and if the stock is up against one of the bands, there is a most likely hood that the trend might be pertaining to an end. I would not let this avoid me getting in a trade, but I would keep a close search it. Similarly, if the stock is going up or down and ready to hit the 20 or 50 day moving typical then this may also stop that directional relocation. It’s also a very conservative method to utilize the DMI/ADX indications.

Based on this data alone, it may seem ideal to put in a buy order every time the price approaches the lower band or sell every time it approaches the upper band. However, just because the market is deemed cheap or expensive doesn’t automatically mean that you should enter or exit a trade right away. We thought that if volatility changed at all it did so only in a very long-term sense, over the life cycle of a company for example. But seeing volatility dynamically change levels over time opened a window for innovation, I wondered if volatility itself couldn’t be used to set the width of trading bands.

Originally designed for analysing commodities, it can be applied to other instruments such as indices and Bollinger Band strategy is used to identify a period where the bands have squeezed together indicating that there is a breakout which can happen. In a similar manner, instead of a 5-day moving average, for Bollinger bands, we use the 20-day moving average. You must be wondering why it is stipulated at 20-day moving average. Well, for one thing, it was specified by the creator of the Bollinger bands, Mr John Bollinger himself.

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