Bollinger Bands are applied directly to price charts, providing a gauge for how strong a trend is, and spotting potential bottoms and tops in stocks prices. Band width fluctuates based on volatility; the ability for Bands to adapt to changing market conditions makes it a popular indicator amongst traders.

To use Bollinger Bands effectively, we must understand how they work, their trading applications, and pitfalls. There are three lines that compose Bollinger Bands: A simple moving average middle band and an upper and lower band. These bands move with the price, widening or narrowing as volatility increases or decreases, respectively. The position of the bands and how the price acts in relation to the bands provides information about how strong the trend is and potential bottom or topping signals.

Bollinger Bands are used on all timeframes, such as daily, hourly or five-minute charts. Bollinger Bands have two adjustable settings: The Period is how many price bars are included in the Bollinger Band calculation. The number of periods used is often 20, but is adjusted to suit various trading styles. The Standard Deviation is typically set at 2. The higher the Standard Deviation, the harder it will be for the price to reach the upper or lower band.

Bollinger Bands denoted 20,2 means the Period and Standard Deviation are set to 20 and 2, respectively. The indicator is calculated using the following formula. First calculate the Middle Band, then calculate the Upper and Lower Bands. The first way to use Bollinger Bands is for analysis. Some common occurrences provide us with information on the direction and strength of the trend.

This information can then be used to confirm trade signals from other indicators or strategies to make trades. These are general guidelines for trading with Bollinger Bands to help analyzed the trend. Adjusting the Bollinger Band settings may help avoid getting false signals from these guidelines. Initially there is a wave lower, which gets close to or moves below the lower band.

When the price moves above the high of the prior pullback the W-Bottom is in place. A long trade is initiated and a stop is placed below the recent lows. The W-Bottom is similar to a Double Bottom chart pattern. One potential profit target is to add the height of the W-bottom to the breakout price. If a major uptrend unfolds, a trailing stop can be used to attempt to capture more profit from the rally. Initially there is a wave higher, which gets close to or moves above the upper band. When the price moves below the low of the prior pullback the M-Top is in place.

A short trade and exit long positions is initiated and a stop is placed above the recent highs. The M-Top is similar to a Double Top chart pattern. One potential profit target is to subtract the height the M-Top from the breakout price.

If a major downtrend unfolds, a trailing stop can be used to attempt to capture more profit from the short position. Bollinger Bands are a helpful indicator, but they have a number of limitations. Bollinger Bands are derived from a simple moving average, which is the average price over a certain number of price bars. Bollinger Bands are reactive, not predictive. Active traders may want a small number of periods or lower standard deviation, while long-term traders may prefer a greater number of periods and a greater standard deviation, so few signals are presented.

By adjusting the settings though it may be more difficult to gauge the trend based on the guidelines or spot W-Bottoms or M-Tops. M-Tops and W-Bottoms may not actually end up not being reversals, but rather just consolidations where the price continues to head in the trending direction after a false breakout. A false breakout is when the price passes through the entry point, initiating a trade, but then quickly moves back in the other direction resulting in a loss. This is why stop losses are used.

Bollinger Bands are comprised of a middle band SMA , and upper and lower bands based on standard deviation which contract and widen with volatility. The Bands are a useful tool for analyzing trend strength and monitoring when a reversal may be occurring.

Combining Bollinger Bands with M and W price patterns aids in spotting major reversal signals. Bollinger Bands are not predictive though. Like other indicators, Bollinger Bands are best used in conjunction with other indicators, price analysis and risk management as part of an overall trading plan. Are you looking for stocks that are showing signs of bottoming out?

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Trading Indicators Ultimate Guide to Bollinger Bands. Cory Mitchell Jun 04, What are Bollinger Bands? Figure 1 shows how Bollinger Bands looks on a chart as they move and adapt with price.

If an uptrend is strong it will reach the upper band on a regular basis. Reaching the upper band shows the stock is pushing higher and buying activity remains strong. When the price pulls back, within the uptrend, if it stays above the middle band and then moves back to upper band it shows a lot of strength.

The same principles apply to a downtrend. If a downtrend is strong it will reach the lower band on a regular basis. Reaching the lower band shows selling activity remains strong. When the price pulls back higher , within the downtrend, if it stays below the middle band and then moves back to lower band it shows a lot of strength.

Another way to use Bollinger Bands is for trading W-Bottoms and M-Tops. A W-Bottom signals a reversal from a downtrend into an uptrend. An M-Top signals a reversal from an uptrend into a downtrend. Get Email Updates Subscribe to receive FREE updates, insights and more, straight to your inbox. News Most Oversold Stocks This Week: June 20 Sneha Shah Jun 20, News Most Overbought Stocks This Week: June 19 Sneha Shah Jun 19, News 25 Best and Worst Performing Stocks This Week: June 15 Sneha Shah Jun 15, Tools Periodic Table of Asset Bubbles.

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