Bollinger Bands - An Essential Tool For Bigger Profits

by sacha tarkovsky

If you have read our article on standard deviation of price you will understand why this concept is essential for all traders and a great way of applying the theory is the Bollinger band.

Bollinger bands are simple to use and are available free on many chart services on the web and will give you a greater insight into market movement and trading for profit.

Let's look at them.

Bollinger bands will help you how to do the following.

1. Predict big trends

2. Spot trend changes

3. Time market entry with greater accuracy.

What are Bollinger Bands?

Bollinger bands are volatility bands drawn around a simple moving average in the center giving you three lines in total.

Bollinger bands are calculated using the standard deviation of a price over the exact same period as moving averages and plotted as lines above and below the moving average.

Moving averages are used to identify the underlying trend and are the middle band.

Bollinger bands then combine this moving average with the volatility of the individual market to create a trading envelope the standard deviation.

The distance between upper and lower Bollinger bands simply give you the volatility of the market traded. The greater the distance the upper and lower bands are the more volatile price of the market traded is.

Bollinger Bands Work

In any market, traded the price rises slowly over the longer term. Prices may become volatile in short periods of time, but will normally come back to the longer term moving average which is defined by the centre band. The center band the"normal" value of the market traded that people are used to paying over time i.e it reflects the supply and demand fundamentals.

The volatility of the outer bands shows how volatile prices are and how far away price is from "normal" value. Short term price spikes tend to be short term and are normally caused as much by trader psychology Bollinger bands can therefore help with the following.




1. Spotting New Trends

When a market makes trades in a narrow range, the Bollinger bands are also narrow and close to the central band this shows a market with low volatility.

This can be a warning that a trending move is about to start.

When prices break above or below the upper or lower band, a signal is given that a trend is about to develop and a trader will go with the break.

2. Timing Entry Levels

The Bollinger bands can when a trend has started help you get into the trend with good risk to reward on a price retracement.

Look for pullbacks to the center band and enter in the direction of the trend.

3. Market Turning points

When the price touches the top of the Bollinger band and pauses a return to the middle band is on the cards (especially in the short term) as prices have moved to far to quickly.

If the price touches the bottom of the Bollinger band and momentum does not follow through the opposite scenario is in place i.e. a buy signal.

Bollinger bands are a great tool not only for warning of a trending move but they will also help you time trades within the existing trend and even help you generate short term sells and buys within the prevailing trends (very useful for swing traders).

Standard deviation of price as a concept of price works and the Bollinger band helps you put the theory into practice.

As with all indicators it does not work all the time and needs to be combined with other tools.

We favor simple trend lines and the best momentum indicator of all - the stochastic indicator which will help you filter out false signals.

Check out Bollinger bands and get a deeper insight into market movement and you will find once you use them you wont trade without them.


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Published at Feb, 21 '07 , Read 1369 times.

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User comments:

psyko79 at Feb, 21 '07 17:51
I use Bollinger Bands in Forex to spot new trends and identify entry points and it's a really great tool. Nice article!
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clifton at Feb, 22 '07 02:14
Thanks psycho. I always like Sacha's articles too
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