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Bollinger bands

Bollinger bands is a technical analysis tool invented by John Bollinger in the 1980s, and a term trademarked by him in 2011. Bollinger bands are used to determine support and resistance levels. This indicator consists of three lines; the middle line is an exponential moving average of price data and the two outside bands are equal to the moving average plus or minus standard deviation (Standard Deviation is a statistical measure that indicates volatility of price). The bands will expand when price becomes volatile and they will contract during less volatile periods.

Having evolved from the concept of trading bands, Bollinger bands and the related indicators %b and bandwidth can be used to measure the "highness" or "lowness" of the price relative to previous trades. Bollinger bands are a volatility indicator similar to the Keltner channel. Bollinger bands consist of:

  1. an N-period moving average (MA)
  2. an upper band at K times an N-period standard deviation above the moving average (MA + KxSD)
  3. a lower band at K times an N-period standard deviation below the moving average (MA − KxSD)

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.



Bollinger bands strategy

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Bollinger bandsThe use of Bollinger bands strategy varies widely among traders. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band. Moreover, the use of Bollinger bands strategy is not confined to stock traders; options traders, most notably implied volatility traders, often sell options when Bollinger bands are historically far apart or buy options when the Bollinger Bands are historically close together, in both instances, expecting volatility to revert back towards the average historical volatility level for the stock.

When the bands lie close together a period of low volatility in stock price is indicated. When they are far apart a period of high volatility in price is indicated. When the bands have only a slight slope and lie approximately parallel for an extended time the price of a stock will be found to oscillate up and down between the bands as though in a channel.

Traders are often inclined to use Bollinger bands strategy with other indicators to see if there is confirmation. In particular, the use of an oscillator like Bollinger bands will often be coupled with a non-oscillator indicator like chart patterns or a trendline; if these indicators confirm the recommendation of the Bollinger bands strategy, the trader will have greater evidence that what the bands forecast is correct.

  1. Bollinger bands strategy is used to determine the boundaries of market movements. If a market moved to the upper band or lower band, then there was a good chance that the market would move back to its average. In the other words, when price closes to upper band, market is overbought and when price closes to lower band, market is oversold.
  2. Another using of Bollinger bands strategy is that to indicate up-trends and down-trends. If price deflects off the lower band and crosses above moving average then price fluctuate between upper band and moving average, it comes to indicate upper price target. It is vice-versa to indicate lower price.

A recent study concluded that Bollinger bands strategy may be effective in the Chinese marketplace, stating: "Finally, we find significant positive returns on buy trades generated by the contrarian version of the moving-average crossover rule, the channel breakout rule, and the Bollinger Band trading rule, after accounting for transaction costs of 0.50 percent." Nauzer J. Balsara, Gary Chen and Lin Zheng The Chinese Stock Market: An Examination of the Random Walk Model and Technical Trading Rules. (By "the contrarian version", they mean buying when the conventional rule mandates selling, and vice versa.)

A paper by Rostan, Pierre, Théoret, Raymond and El moussadek, Abdeljalil from 2008 at SSRN uses Bollinger bands strategy in forecasting the yield curve.

Companies like Forbes suggest that the use of Bollinger bands strategy is a simple and often an effective strategy but stop-loss orders should be used to mitigate losses from market pressure.


Share market strategies

The daytrader

  1. Opening range breakout
  2. Market timing
    To buy Satyam after it was rescued from brink of bankruptcy, you had to have huge confidence in your ability to read trends.
  3. Elliott wave trader
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    1. What is hedging?
    2. How to hedge?
  5. Rules for investing
  6. Moving average
    1. MACD
    2. Stochastic oscillator
      Indicates whether market's moving to new highs, new lows or just moving nowhere.
    3. Bollinger bands
    4. Relative strength index
  7. Swing trading guide
  1. Trading for a living
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    Gaining the knowledge is the first step to learning how to trade on the open market.
  3. Price action trading
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      Traders violate it surprisingly often!
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    For those who do not know about day trading.


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