Bollinger Bands Indicator
This is one of the more popular indicator tool used in trading as it has shown its reliability by yielding accurate results and signals. The Bollinger Bands is described as a dynamic indicator as it can adjust and adapt to new market conditions and get shaped as prices change. It is also responsible for measuring momentum and market volatility.
It is best used, though, in analyzing the strength of a trend and yield significant information relative to the market trend.
How Bollinger Bands works
This indicator tool operates using three moving averages:
Upper Band – 20-day simple moving average + double standard deviation
Middle Band – 20-day simple moving average
Lower Band – 20-day simple moving average – double standard deviation
When the distance between the upper bands and the smaller bands increases as the volatility grows, it gives traders a signal that price is developing in a particular trend. The Middle line’s direction correlates with the direction of the developing price.
The signal that this tool gives to the trader of when to buy or to sell in when the price crosses the Middle line from above or below.
Trading Strategy using the Bollinger Bands
The upper bands and the lower bands used as price targets are known as the best way to utilize Bollinger Bands as a trading strategy. The upper band serves as the upper price target when the prices go below the Middle line, whereas the lower band becomes the lower price target when the prices go above the Middle line.
During a downtrend, prices typically play between the Middle line and the lower band. Prices that go above the Middle line are an indication of a reversal in trend to the upside, which suggests a “buy” signal to the trader.
The Middle line is a regular Moving Average:
ML = SUM [CLOSE, N] /N
The Top Line is ML a deviation higher:
TL = ML + (D*StdDev)
The Bottom line is ML a deviation lower
BL = ML – (D*StdDev)
N – Number of periods used in calculation;
ML – simple Moving Average
StdDev – Standard Deviation