Welcome to Technical Tuesdays, where each Tuesday we'll publish a blog post about a different method of technical analysis. Just because we publish something doesn't mean we use it, but an informed trader is a successful trader so the general knowledge can be helpful. Today's topic: Bollinger Bands.
Bollinger Bands are a popular technical analysis tool used by traders to identify potential trading opportunities in financial markets. They were developed by John Bollinger in the 1980s and have since become a widely used indicator among traders.
Bollinger Bands consist of three lines that are plotted on a price chart: a middle band, an upper band, and a lower band. The middle band is a moving average, typically a 20-day simple moving average, which represents the average price over a specific period of time. The upper and lower bands are calculated by adding and subtracting a multiple of the standard deviation from the middle band.
The standard deviation is a measure of volatility, and the multiple used to calculate the upper and lower bands is typically set at two standard deviations. This means that the upper and lower bands are located two standard deviations away from the middle band.
The purpose of Bollinger Bands is to identify potential trading opportunities based on changes in volatility. When prices are trading within the bands, it suggests that the market is in a period of consolidation, and there may not be a clear trend. When prices break outside of the bands, it suggests that the market is experiencing a period of increased volatility, and a new trend may be forming.
Traders can use Bollinger Bands in a variety of ways to inform their trading decisions. One approach is to look for price to bounce off of the upper or lower band and retrace back towards the middle band. This can indicate a potential reversal in the market, and traders may look for a long or short entry depending on the direction of the trend.
Another approach is to look for a squeeze in the bands. A squeeze occurs when the upper and lower bands start to converge, indicating that the market is experiencing a period of low volatility. Traders may use this as a signal that a breakout is imminent and may look for a long or short entry depending on the direction of the breakout.
It's important to note that Bollinger Bands should be used in conjunction with other indicators and analysis methods to make trading decisions. Like any technical analysis tool, they are not a foolproof method for predicting market movements.
In conclusion, Bollinger Bands are a widely used technical analysis tool that can help traders identify potential trading opportunities based on changes in volatility. They consist of three lines plotted on a price chart, and traders can use them in a variety of ways to inform their trading decisions. However, traders should use caution and not rely solely on Bollinger Bands when making trading decisions.
Here is what they look like on a chart:
And here is how you add them to the chart in Thinkorswim via Studies > All studies > A-B > BollingerBands: