Bollinger Bands (shows price movement)
As one can see from this picture, Bollinger Bands consist of three lines. A middle line that is a “stock’s Moving Average” and two other lines above and below that are standard deviations. The bands expand and contract. They expand as the stock becomes more volital and contract as it trades in a tight pattern.
Why use Bollinger Bands? How are they helpful to us as traders?
The upper and lower Bands will help us detemine what we call “over-bought” and “over-sold” levels in the stock.
When a stock pushes through the upper band, it is considered “over-bought.”
When it pushes through the lower band, it is considered “over-sold.”
This is very heplful when we are looking at a stock that has a “trading zone” and is moving sideways. If we are using a “Spread” strategy, it will help us determine when to get in because the stock will usually trade between the top and lower bands. Buying when the stock breaks into the lower band and is considered “over-sold” is a good signal.
As we will continue to learn, we should always use more than one indicator to make a trade. When we do make a trade, we should always have an exite strategy in case our observations are wrong. A stock may hit a lower band, but if it does not correct, it may continue on a dowward pattern riding the lower band.
The middle Band can help us determine the strength of a movement. As a moving average, the middle band can help us determine how strong a particular trend is.
If a stock is trending upward and consistently bouncing off the middle band for its lows, then we know we have a very strong upward trend.
The middle band is a gage for us to determine how strong the trend really is. It will help us identify strength and weakness in the movement of the stock.
There are two different formations that we can find in a Bolinger Band indicator that may help us with buy and sell signals that are important.
A Double Bottom Buy Signal—when a new low forms and pierces the lower band and is subsequently followed by another low that does not pierce the lower band, we have a possible bullish buy signal. The second low may be lower than the first, but the important thing is that it does not pierce the lower band like the first one did. This “bullish set-up” will be confirmed by a movement through the middle bands.
A Double Top Sell Signal— is just like the double bottom buy signal, this is a “bearish set-up” to get rid of the stock. It is opposite of the previous one. We are looking for two tops. The first top breaks through the upper band. The second top does not break through the upper band. The bearish turn is confirmed as the stock moves downward through the middle band.
What will we use Bollinger Bands for?
Determine the strength of a trend, up or down.
Identify “over-bought” and “over-sold” points.
Use “double tops/bottoms” as “signals in a possible trend reversal.
Using Bollinger Bands alone is not a good idea to determine buying and selling. It is one indicator we will use with a series of others.