What is Bollinger Band Indicator?- Trading Strategy Explained with Example
For a long time, I was thinking to introduce you all to unique terms from the stock market aspect. In the same series, not only we will understand “What is Bollinger Band Indicator”. But also explain which trading strategy would be the right fit for this indicator with an example.
What is Bollinger Band Indicator?
To understand the Bollinger band, you should know the basics of technical analysis so that you can interpret the results from the chart. As the name suggests, the Bollinger band consists of three bands named upper, lower, and middle bands. Bollinger band comprises the volatility indicator. To measure volatility we use standard deviation therefore Bollinger Bands are price envelopes drawn at a standard deviation level above and below the price’s simple moving average. In the Bollinger band, we use 2x times of standard deviation which gives approximately 95% accurate results.
In the Bollinger band concept, we use Period and Standard Deviations, as the two key parameters. the default numbers for a period and standard deviations are 20 and 2, respectively, but you can change them.
Bollinger band is used to evaluate if prices are relatively high or low. They’re used in pairs, with upper and lower bands, and with a moving average in between. Use the pair to double-check indications generated by other indicators.
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How does this work?
To understand this we should know the bands widen when there is a price increase. Whereas, narrows down, when there is a price decrease. It helps investors in making trading decisions concerning entry or exit points in the market.
By plotting the upper Bollinger Band and the lower Bollinger Band, it is possible to determine which of the two bands the stock’s current price is closest to.
If the current stock price is approaching the upper Bollinger Band, it may indicate that the stock is overbought, and vice versa. Investors can decide whether to sell or buy stocks based on whether they are overbought or oversold.
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Bollinger Band Trading Strategy Explained with Example
What we have understood from the working of the Bollinger Band is that bandwidth between the upper and lower bands represents the volatility in stock price for a given period. Usually, the maximum lifespan of price movement occurs between the two bands. As a result, to make maximum returns newbie investors should ensure this strategy.
- You buy when stock prices are closer to the lower band and forming a W pattern in the lower band.
- You should prefer to sell the stock when it’s reaching the upper or closer to it. As there are high chances once it touches the upper band reversal in trend happens and you may the opportunity.
- You should easily determine the entry and exit point in the stock with the band. Or else you may incur losses if the price breaches on either side of the band resulting in a miss of opportunity.
- In case there is strength in the stock price it may push the band on either side. This indicator works wonders in intraday trading as liquidity drives day trading. In case it goes up or below the band, then the stock retraces back generally from the middle band. If its remains on either side of the band for a long time then it gives a breakout and you may expect a sudden reversal of a trend. Therefore, you need to look for the timing of the reversal so that you can make the money.
Bollinger bands are nothing more than a tool. It has weaknesses and does not always give trustworthy indications. It can assist you in staying on-trend and spotting potential reversals. You’ll need to align the indicators with the rules stated above to accomplish this. The indicator’s random or default settings may not operate well. Before utilizing the indicator for real trades, adjust it and test it out with paper trade. Do combine this indicator analysis with another indicator for an accurate result.