Bollinger Bands is a heavily used technical analysis indicator by stock, futures, and even option traders. To begin, Bollinger Bands consist of:
- Moving Average
- Lower Band
- Upper Band
The moving average, typically 20 periods, forms the center of the Bollinger Band. The upper Bollinger Band is two standard deviations above the moving average line and the lower Bollinger Band is two standard deviations below the moving average line.
Generally speaking, 95% of values should be between two standard deviations. Therefore, it is a rare occurrence when stock prices rise above or below the Bollinger Bands. However, since the moving average and standard deviations used for the Bollinger Band calculation are historical values, great caution must be applied when saying that exactly 95% of future stock prices should be contained between the upper and lower Bollinger Bands.
Interpretation: Stock & Futures Traders
There are numerous interpretations of the Bollinger Bands. The first interpretation is buying when prices touch the bottom Bollinger Band or selling when prices touch the top Bollinger Band. The second interpretation is buying when prices breakout above the upper Bollinger Band, or selling when prices breakout below the lower Bollinger Band; this strategy often occurs after a period when stock prices have not moved for a while. The breakout signals that the stock has rested and is now ready for more activity.
Interpretation: Option Traders
The third interpretation is used often by option traders. When Bollinger Bands are close together, prices are calm and usually options are inexpensive, so options traders buy options in hopes that prices will start to move again. When stock prices move again, option prices increase, so option traders can sell the options they bought cheaply for a profit. When Bollinger Bands are far apart, prices are erratic and option prices are relatively expensive, so options traders sell options that prices will calm down. If the prices calm down, option prices should decrease and that means the trader can buy back their sold options for cheaper than they purchased them for, netting profits.
Comparison to Moving Average Envelopes
Bollinger Bands change the distance above and below the moving average because the standard deviation of prices is always changing. In contrast, Moving Average Envelopes are a constant percentage above or below the moving average. Thus, Bollinger Bands could have viewed as more adaptable to price movement than Moving Average Envelopes.
Bollinger Bands are one of the most popular and versatile technical analysis indicators used today by stock, futures, and option traders. The following link provides more information and detailed charts of Bollinger Bands . For more information on over 66 technical analysis indicators and information on Japanese Candlestick Charts visit www.OnlineTradingConcepts.com