A complete Guide to Understanding Bollinger Band

Investors and traders use Bollinger Bands to help understand market volatility. Two price bands are plotted above and below the moving average line graph with standard deviation. Market volatility is represented by gaps between bands drawn from moving average lines.

Bollinger Bands, a trademark chart created by John Bollinger, a well-known technical trader who used it for predicting market sentiment shifts, setting triggers when a stock has become overbought/oversold.

The middle line in this graph represents a simple moving average. The two other lines are the upper and lower limits of the price envelope. These bands can be used to analyze price fluctuations and to determine general trends for various asset classes.

A short history of trading bands

There were many other attempts to capture market volatility before John Bollinger's idea. Wilfrid Ledoux, who used the Dow Jones Industrial Average's monthly highs and bottoms to predict market movements over time, started using them in 1960. The history of trading bands was lost after that. Hurst revived it. Many others attempted to create similar trade bands, but were unsuccessfully inspired by Hurst. Percentage bands were popularized in the 1970s. It was simple to use, and gained many fans. It was a simple graph showing highs and lowests. The graph was plotted against a user-specified percentage. Bollinger Bands were developed from Donchian Bands' idea. This is a price envelope band that shows the highest and the lowest price differences over a number of days. Bollinger Bands have a distinct advantage over Donchian Bands because they only take into account recent highs and lowers. Standard deviation is used, which allows it to be dynamic and adaptable to market pulses.

Bollinger Bands

The first moving average for a given period is usually a simple moving average of 20 days (SMA) and it is placed on a line chart. To represent price fluctuations, standard deviation points against the graph are added. A standard deviation is a mathematical method to determine how much a value differs from the group average.

Calculate standard deviation using this formula

The standard deviation (SD), is the square root if the sum of all the numbers in the sample divided by the mean, is called the summation. Bollinger calculates upper and lower bands by multiplying SD with two and adding or subtracting the number from each value. This will plot the upper and lower values, respectively. This is how it works.

Bollinger Bands formula,

BOLU=MA(TP,n)+m*s[TP,n]

BOLD=MA(TP,n)-m*s[TP,n]

Where?

BLOU = Bollinger Upper Band

BOLD = Bollinger Lower Band

MA = Moving Average

TP= Average Price (High+Low+Close). / 3

N = The number of days in the Moving Average (typically 20).

M = The number of SD (typically 2).

s [TP, ] = SD over the last n periods.

Bollinger Bands can be used to predict market sentiment changes because of their simplicity. It can be modified to fit the trading patterns or stock it is predicting.

How do you interpret Bollinger Bands

Bollinger bands are a way to tell if the market is volatile or not. Market volatility is measured by the gap between moving average lines and the bands. The bands will move closer to the moving average graph when market volatility is high. They will contract when volatility drops. It can also indicate when sentiment is changing. Bollinger Bands is a trading strategy that allows traders to predict when a stock will be overbought. Overbuying is when the stock price hovers close to the upper range. The stock is also considered oversold if it moves within the lower range.

Here are some ways to study the patterns

Get

A part of the price envelope that is close to the other two lines, called a squeeze, signifies less volatility. To anticipate market volatility, traders look out for squeezes within Bollinger Bands.

Breakouts

Breakouts refer to price points that are outside of the price range. This isn't a market signal and should not be considered a common phenomenon. It does not tell you if the market is more or less agile. Breakeven does not indicate which direction or how far the market will move.

W bottoms

Double bottom, or W bottom, is a technical analysis that indicates when two stock prices hit simultaneously. This creates a W pattern on a graph and gives rise to the name. Bollinger uses it as a part Arthur Merrill's work. Bollinger has four steps for identifying a W.

The price falls below the lower limit on the first occasion. It then rebounds and follows with a second drop that holds above the lower limit. The W pattern is completed by a strong rebound, which breaks a resistance level.

M Tops

M-tops are the opposite of Wbottom. This happens when stock prices reach a high and then slump to rise again. These highs can be more difficult to interpret. It is possible to interpret the failure of the second-high to reach the upper bands as a sign that momentum is losing strength. This could indicate a trend reversal. This is an example M-pattern.

Bollinger warns that breaking the upper or lower limit of a price doesn't necessarily signal a change in trend or provide trading signals. These bands indicate when a stock's strength or weakness. The same principle applies to a momentum oscillator. Bullish trends don't necessarily indicate prices close to the upper limit, and vice versa.

Limitations on Bollinger Bands

It cannot be used as a standalone tool. Bollinger recommended that it be used with at least two to three non-correlated trading tools in order to receive the right market signals.

It is calculated using a simple moving average and places more weight on older data than on recent data. This reduces the importance of new data and can impact decision-making. Traders should adjust it to meet their needs. They also need to consider current information when making trading decisions.