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Sunday, June 5, 2011

Bollinger bands


Bollinger bands intro

Bollinger bands is the topic of the post. It is a technical indicator developed by John Bollinger in 1980‘s. In the words of John Bollinger himself this indicator should provide a relative definition of high and low. The indicator itself like many other technical indicators should not be used alone but in combination with other indicators of a different nature such as RSI and money flow. 

Structure of Bollinger bands

Indicator consists of three parts: upper band, lower band and the middle band (which is usually 20 sma). When a price of a security reaches the upper band we may assume that prices are high, when it reaches the lower band we assume that prices are low and when it is fluctuating around middle band we may assume that prices are neither overbought nor oversold and could actually be going sideways. 

Bollinger bands and M patterns

I like using Bollinger bands, especially for finding potential bottoms and tops in financial markets. Those are usually found as M patterns for tops and W patterns for bottoms. They can be typically known as double tops and double bottoms and Bollinger bands indicator helps us to identify those. Especially if you look at long term charts! A typical reversal in an uptrend happens after a security has been in a trend for some time. One day it starts going back sharply, then stops and tries to revisit its' previous high. It usually fails. This going down causes bands to flatten and when the security comes back to retest its previous high it usually hits upper band which now acts as a resistance. Then the security starts collapsing and goes through its’ previous lows. 

Bollinger bands and W patterns

W pattern is formed in a downtrend when a security has been going down for some time. At some point it rallies up. Then it starts coming down to retest its’ previous low. This rally causes bands to flatten and when the price of a security reaches previous low or comes close to it, it hits the lower band, which acts as support now. After that the security usually reverses and starts climbing up. 

Bollinger bands in ranges

Bollinger bands are also very good in range bound market, when securities are fluctuating between highs and lows of their ranges. In those particular periods bands are usually pretty flat and act well as support and resistance areas. It is advisable of course, to implement some other technical indicator and various reversal patterns to trade with the bands, and not to take a touch of a lower or upper band as a sign to sell or to buy a security. Take RSI divergences (on 8 hour chart) as an additional indicator and you will get pretty powerful signals to follow. 

Bollinger bands and trends

One can also use Bollinger bands to identify emerging trends. Prices closing beyond the bands might signal not a reversal and coming back to the range, but a breakout that can lead to a prolonged trend in securities. It means you need to look for opportunities to enter positions in the direction of the move and keep them before you see any serious signs of reversal (bands flattening). 

Conclusion

So, as you may see Bollinger bands can be used for trading any type of market under various market conditions: ranges, trends, reversals. What you should remember is that it is not safe to use any indicator alone without getting some confirmation from other technical indicators. Try to play with Bollinger bands on various times frames to see the big picture and identify the most important levels of support and resistance. I hope you will learn to use the tool profitably. 
I will post more charts in the coming week (after repairing my computer).

Read my previous post:


More on Bollinger bands visit John Bollinger site:

http://www.bollingerbands.com/

 
Disclaimer
Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.