Bollinger Bands highlight the volatility of the market by forming a channel encompassing the price curve of a financial asset.
Traders need reliable and accessible tools when practicing technical analysis in order to anticipate price movements and place the most profitable and least risky orders. Since the 1980s, Bollinger Bands have largely demonstrated these qualities, and continue to support investors.
What are Bollinger Bands ? How are they calculated ? How are they interpreted ? How can you use Bollinger Bands in trading ?
Here is a summary of all the information you need to know to increase your gains on the financial markets by using Bollinger Bands.
In the 1980s John Bollinger, on his way to becoming a renowned financial analyst and author, began to develop the indicator that we now call the "Bollinger Bands", a technical indicator used in financial analysis. They are widely used and owe their popularity among professional and private traders to their simplicity of use and proven effectiveness.
Bollinger Bands are formed by three curves superimposed on the price chart of a financial asset. The upper and lower bands form a channel within which the price moves most of the time. They thus make it possible to measure the volatility of the price of the asset studied. This technical indicator offers a lot of additional information that is appealing to traders who want to increase their profits. Bands indicate trend continuations and changes, market consolidation phases, as well as potential peaks and troughs in the price of an asset and therefore, price targets to aim for.
Bollinger Bands are made up of three curves. The middle curve is a moving average calculated over a given period, usually 20 days. Thus, this moving average is equal to the sum of the 20-day price closes, divided by 20. The upper and lower curves are located at a fixed distance above and below the moving average curve. Generally, their distance is equal to 2 standard deviations from the mean. Thus, the upper curve is equal to the 20-day moving average plus 2 standard deviations, and the lower curve to the 20-day moving average minus 2 standard deviations. In this configuration, and assuming that market returns follow the Normal Law (random distribution of returns), the price curve of the asset studied remains inside the channel 95% of the time.
Overall, the appearance of the bands itself offers an overview of the state of the market to the trader. Indeed, if the channel is narrow, it means that the price of the asset is not moving much, and therefore the market is in a consolidation phase. On the other hand, if the channel is very wide, the prices oscillate a lot and the market volatility is high. In addition, the tightening of the channel usually heralds a major price change to come. Therefore, although the trader does not know how long the tightening phase will last, he can take a position as soon as he notices the beginning of the gaping phase. Although rare, channel breaks give important signals to investors.
Since prices move within the Bollinger Bands 95% of the time, a breakout signals an unusual event that may signal the beginning of a new momentum phase. However, as these events are relatively infrequent, traders will be more interested in playing failures, i.e. making the same buy and sell orders as if the bands were playing the role of support or resistance. Finally, Bollinger Bands allow investors to spot trend reversal patterns. The Double Top (or "M") and Double Bottom (or "W") patterns are particularly relevant.
Indeed, in the case of a bullish trend, a first high reached by the prices beyond the upper Bollinger band, and a second high reached inside the channel, announce a downward reversal. Conversely, a first low outside the lower band and a second low inside the channel signal an upward reversal.
Bollinger Bands are major technical indicators in financial price analysis. They are easy to access, they provide traders with important information on asset price movements and overall market trends.