David Waring

Bollinger bands trading strategies

In our last lesson we learned about the Stochastic Oscillator and how traders use this in their trading. In today’s lesson we are going to learn about a technical indicator, which helps traders gauge the volatility and how current prices compare to past prices.

Bollinger Bands are comprised of three bands which are referred to as the upper band, the lower band, and the center band. The middle band is a simple moving average which is normally set at 20 periods, and the upper band and lower band represent chart points that are two standard deviations away from that moving average.

Example of Bollinger Bands


Bollinger Bands Explained

Bolinger bands are a good tool to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past. The basic premise of Bollinger bands is that price should normally fall within two standard deviations (represented by the upper and lower band) of the mean which is the center line moving average. If you are unfamiliar with what a standard deviation is you can read about it here. As this is the case trend reversals often occur near the upper and lower bands. As the center line is a moving average which represents the trend in the market, it will also frequently act as support or resistance.

The first way that traders use the Bollinger bands indicator is to identify potential overbought and oversold places in the market. Although some traders will take a close outside the upper or lower bands as buy and sell signals, John Bollinger who developed the indicator recommends that this method should only be traded with the confirmation of other indicators. Outside of the fact that most traders would recommend confirming signals with more than one method, with Bollinger bands prices which stay outside or remain close to the upper or lower band can indicate a strong trend, a situation that you do not want to be trading reversals in. For this reason selling at the upper band and buying at the lower is a technique that is best served in range bound markets.

Example of Buying and Selling at the Upper and Lower Band:


Large breakouts often occur after periods of low volatility when the bands contract. As this is the case traders will often position for a trend trade on a break of the upper or lower Bollinger band after a period of contraction or low volatility. Be careful when using this strategy as the first move is often a fake out. If you are unfamiliar with fakeout, this technical analysis term is described here.

Example of the Bollinger Band Contraction


As Bollinger bands paint a good picture directly on the price chart of how high or low price is relative to historical prices, this is a good indicator to use in conjunction with other methods such as some of the currency chart patterns that we have learned so far and some of the candlestick patterns which we will learn in future lessons.

Bollinger Bands with Multiple Confirmation


As Bollinger Bands are one of the most popular indicators around I have created a special page on InformedTrades.com which lists multiple resources for those looking for more information on Bollinger Bands trading .

Other Links From Around the Web to Help You Learn About Bollinger Bands

Bollinger bands - Wikipedia, the free encyclopedia
Using Bollinger Band "Bands" To Gauge Trends
www.BollingerBands.com: Bollinger Bands Tutorial
www.BollingerOnBollingerBands.com: Home Page

That’s our lesson for today. You should now have a good understanding of Bollinger bands and how traders use these in their trading. In our next lesson we are going to go over the Average Directional Index or ADX, which helps traders identify the strength or weakness of a trend so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

peertrade

Dave,

I am enjoying every bit of your site.Excellent work.

I would like to know if these indicators moving avg,bollinger bands and others can be used for used for Mutual funds and ETF's too?


Peer

David Waring

Hi peertrade,

Glad to hear from you and thanks for the compliment I am glad you like the site.

As I understand it when you buy or sell a mutual fund, the transaction takes place at the close of trading regardless of what time the trade is placed. So for example if you buy XYZ mutual fund at 10:00 am, the actual trade is not done until the close of that days trading.

Because of this and the fee structure that is in place on many types of mutual funds, they are really set up for long term investing rather than trading. As technical analysis is generally thought of as a traders tool, from my experience most people do not use it when looking to invest in a mutual fund.

ETF's on the other hand trade like just like a stock, so if you buy an ETF at 10 AM then the trade is done at 10 AM and the fee structure is very low and does not include any type of front or back end loads (% of capital that you pay to enter and exit the funds). With this in mind ETF's are very popular amoung traders, many of whom use technical analysis to trade them.

Hope that helps.

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.