What are Bollinger Bands?
Bollinger Bands are a volatility-based indicator that was created by John Bollinger in the 1980s. An on-chart technical tool, Bollinger Bands use price action to create different signals.
The indicator plots on the chart and embraces the price action.
Structure of the Bollinger Bands Indicator
The Bollinger Bands indicator consists of three lines: upper band, lower band, and a middle line.
- Upper band = 20-day simple moving average +/- (20-days standard deviation x 2)
- Lower band = 20-day simple moving average -/- (20-days standard deviation x 2)
- Middle line = 20-day simple moving average
Since the indicator uses the standard deviation of the price, it puts an emphasis on periods with higher volatility.
How Bollinger Bands Work
Bollinger Bands tell you when volatility is high and when it’s low. Since trends are more likely to form during higher volatility, the bands are a useful indicator for trend hunting.
When volatility is high, you’ll see that the bands expand and gain distance from each other, which shows that the market is currently loud and there are many market players. Since the bears and the bulls fight for dominance, one of the two sides is likely to overpower the other, which causes the trend.
When volatility is low, you see the bands close to each other. When the bands are tight, this means the market is currently quiet, and not many people are taking part. In such cases, you are very likely to find a consolidation on the chart. The price will move sideways and an overall trend will be missing.
How Bollinger Bands Can Help Your Strategy
You can always add the Bollinger Bands indicator to your analysis toolbox. It is a great tool for visualizing the real volatility on the chart so you can distinguish valid trends from fake ones.
Although the Bollinger Bands is a great standalone indicator, you can also combine it with another tool to get an extra confirmation of your signals. One good Bollinger Bands partner is the momentum indicator. It can work as a secondary confirmation tool in your trading strategy.
The basic signals of the momentum indicator are very simple.
- If the line is above the 100 level, it’s a bullish signal.
- If the price is below the 100 level, it’s a bearish signal.
- If the line is high above the 100 lines, this indicates strong bullish momentum.
- If the line is low below the 100 level, this signals about a strong bearish momentum.
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