What Are Bollinger Bands?
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Bollinger bands are an effective technical analysis tool that is used to measure the volatility in the market. So what are Bollinger Bands? Bollinger bands are bands plotted above and below a moving average. The recommended moving average is the 20 period average that is an effective representation of the intermediate trend.
Bollinger bands may be applied to any market or security. Any timeframes from daily, weekly, monthly to intraday can be used. Primary advantage of using these bands is to check if the prices are relatively low or high.
Volatility is a very important variable for an options trader. The more volatility there is on the underlying stock, the more option price will swing. Now when the volatility in the market is low, these bands get narrow and when the volatility in the market increases,these bands widen too.
When prices are above the upper band, this is taken as a sign of strength in the market. However, when the prices are below the lower band, this is taken as a sign of weakness in the market. Now, prices can be within the band or outside the band. When prices are outside the bands, this is taken as a signal that the trend is most likely to continue.
When the bands happen to tighten as they do when the volatility in the market decreases, rapid and substantial price moves often take place after the band tightens. This is something an experienced trader always keeps in mind. Now, Bollinger Bands are mostly used in conjunction with other technical indicators like the Commodity Channel Index (CCI), Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI) and others.
The bands that are plotted above and below this moving average are the moving standard deviations. These bands vary in distance from the average as a function of market volatility. Two standard deviations above and below the average is the recommended settings for these bands.
In case of very short timeframes, the moving average period should be lowered to 10 and the standard deviation should also be decreased to one and a half for the two bands. But sometimes, you want to trade a longer timeframe. In that case, 50 is usually used as the period for the moving average with longer trends and the standard deviation settings for the two bands should be increased to two and half standard deviations.
For the stock market as well as individual stocks, 20 period moving averages are the best. However, the average that is selected should be descriptive of the timeframe chosen. Trading bands is one of the most powerful concept available to a trader.
Now these bands do not provide absolute signals when prices touch these bands. These signals should only be taken as relative and confirmed in conjunction with other technical indicators.
Article Source: Articlelogy.com
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