The Basics of Bollinger Bands®

Interpreting Bollinger Bands can give traders and investors a better understanding of potential market movements. Bollinger Bands typically use a 20-period moving average, where the “period” could be 5 minutes, an hour or a day. By default, the upper and lower bands are trading tutorials and platform video guides set two standard deviations above and below the moving average. However, traders can customize the number of periods in the moving average as well as the number of deviations. Before we get to how they can do that, let’s talk about what they are and what they look like.

  1. Traders should adjust their SMA and standard deviation assumptions accordingly and monitor them.
  2. Traders should also pay attention to volume when trading with Bollinger Bands – higher volume often confirms a valid reversal signal.
  3. Bollinger Bands® are highly technical tools that give traders an idea of where the market is moving based on prices.
  4. We tested the many ways to trade Bollinger Bands, but the research shows that none are more than 47% successful.
  5. By using the RSI in combination with the Bollinger Bands®, you can get an even better idea of a trend’s strength.
  6. 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.

Further, the width of the band can be an indicator of its volatility (narrower bands indicate less volatility while wider ones indicate higher volatility). Bollinger Bands are constructed using a moving average (SMA) and two upper and lower bands. The SMA is usually set to a 20-period simple moving average, although it can be adjusted according to your trading strategy. The upper band is calculated by taking the SMA plus two standard deviations, while the lower band is determined by subtracting two standard deviations from the SMA. Bollinger Bands are a popular technical analysis tool that uses a simple moving average (SMA) and two standard deviations (SD) to calculate the upper and lower bands.

Mean reversion assumes that, if the price deviates substantially from the mean or average, it eventually reverts back to the mean price. Bollinger Bands® are often used along with the relative strength indicator (RSI) as well as the BandWidth indicator, which is the measure of the width of the bands relative to the middle band. The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its operating subsidiaries. Neither Schwab nor the products and services it offers may be registered in your jurisdiction.

Bollinger Bands produced a weak 33% average success rate versus a long-term buy-and-hold strategy. Our 12-year tests of the 30 Dow Jones Industrial Average stocks prove Bollinger Bands should be avoided. The basic idea behind the Bollinger Band Breakout strategy is to buy when the price breaks above the upper band and to sell when the price breaks below the lower band. This signals a potential change in market volatility and an opportunity to enter or exit a trade. When there is neither a buy nor sell signal generated by this indicator, that could suggest employing market-neutral strategies. Recently, the S&P 500 has trended lower, and a move toward the lower band might generate a buy signal.

The outer Bollinger Bands® are based on price volatility, which means that they expand when the price fluctuates and trends strongly. Conversely, the bands contract during sideways consolidations and low momentum trends. The longer the how to short crypto in the us candles and the candlestick wicks, the higher the volatility is and, therefore, the further apart the Bollinger Bands® are going to be. If the stock’s price is below the middle of the bands, it can be an indicator of a downtrend.

What are Bollinger Bands?

As long as prices do not move out of this channel, the trader can be reasonably confident that prices are moving as expected. The Bollinger Bands ® indicator is ideal for trend-following trading, and trend-continuation trading, and can even be used by reversal traders. In the screenshot below, the price first showed a Bollinger Bands ® exhaustion. The exhaustion is confirmed when the price fails to reach the upper Bollinger Bands ® in an uptrend. Whereas previously in the uptrend, the price was able to reach and trade outside the upper band, during the exhaustion, the price could not continue the trending phase. Another pattern of note is a Bollinger Band “squeeze.” This occurs when volatility reaches a relative low in the context of recent price action.

The “lower band” is calculated by subtracting two times the standard deviation from the SMA. These bands provide an indication of the volatility of a security and are used to identify potential overbought or oversold conditions. One of the main limitations is that it shouldn’t be used as a standalone tool. In fact, Bollinger Bands® should be used with other non-correlated indicators. Doing so may give you additional market signals that are much more direct. Another drawback is that they are calculated using a simple moving average.

Watching the price behave like this, a trader may wonder if the stock is in a new uptrend, or if it has met its resistance. No, overall, Bollinger Bands are not accurate using the standard configuration, with a 67% failure rate across the 30 Dow Jones stocks. Using Bollinger Bands with an SMA 10 and only using it as a buy signal when the price crosses the lower band improves accuracy to 55%.

This generates a market-beating 766% profit versus an index investing return of 555%. With this strategy, traders may look for additional signals to confirm the reversal. This could include using other indicators or chart patterns, such as a double bottom or candlestick pattern.

A Tool for Trend Traders and Faders

When it makes this move above the earlier pullback in price, it’s said to be a W-bottom. When the price breaks through the upper or lower band, the trader buys or sells the asset, respectively. A stop-loss order is traditionally placed outside the consolidation on the opposite side of the breakout. For a given data set, the standard deviation measures how far numbers are from an average value.

Traders should also pay attention to volume when trading with Bollinger Bands – higher volume often confirms a valid reversal signal. Finally, traders can use Bollinger Bands to identify reversals in the market. If the price touches the lower band and reverses higher, traders can enter a long trade, and if it touches the upper band and reverses lower, they can enter a short trade. This strategy works best when markets are ranging or consolidating – in these conditions, Bollinger Bands act like support and resistance levels. One popular way to trade Bollinger Bands is to buy when the price crosses above the lower band and sell when it crosses below the upper band. This strategy works best in trending markets, as it will help traders capture larger gains from long-term trends.

This squeeze can be followed by a period of increased volatility and may result in a significant move by the stock to the upside or the downside. Narrowing Bollinger Bands (i.e., when the bands move closer together) could suggest that volatility is decreasing—as investor sentiment potentially becomes more optimistic or complacent. As the chart above shows, the bands have narrowed somewhat of late, suggesting there may be some short-term complacency. One technical indicator—Bollinger Bands—suggests investors may be feeling uncertain about US stocks over the short term. By combining Bollinger Bands® with other indicators, you can get a better idea of what the bands are telling you as well as the strength of a trend and which direction it’s headed. To identify this pattern, look for an initial wave in price that’s trending low, where the SMA moves close to or even slightly below the lower band.

How to make money trading Bollinger Bands?

Want to test any indicator, chart pattern, or performance for any US stock? Our Trendspider review unveils insights into discovering the most powerful trading strategy development ripple’s projected performance in 2021 and beyond and testing service. Upper resistance and lower support lines are first drawn and then extrapolated to form channels within which the trader expects prices to be contained.

What are the Cons of the Bollinger Bands?

The more informed you are, the better primed you to make smarter trading decisions. StocksToTrade is stocked with plenty of features to help you make the most of your technical analysis. As you might guess from the reversed shape, the M-tops pattern is a trend reversal. What you’ll see here is an initial higher wave in price, which is close to or even slightly above the upper band.

After a period of consolidation, the price often makes a larger move in either direction, ideally on high volume. Expanding volume on a breakout is a sign that traders are voting with their money that the price will continue to move in the breakout direction. As John Bollinger acknowledged, “tags of the bands are just that, tags, not signals.” A tag (or touch) of the upper Bollinger Band® is not in and of itself a sell signal.

However — and this goes across the board — you should never rely on one single indicator to make a final decision about whether to make a trade. By using the RSI in combination with the Bollinger Bands®, you can get an even better idea of a trend’s strength. Bollinger Bands® and Keltner Channels are different, but similar, indicators. Here is a brief look at the differences, so you can decide which one you like better. A double bottom occurs when there is a fall in price, followed by a rise, followed by another fall that is close to the previous low, and finally another rise. The best way to succeed with Bollinger Bands is by using a specific setup tested for higher reliability.

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