Bollinger Bands are a volatility indicator made of three lines: a 20-day simple moving average in the middle, an upper band two standard deviations above it, and a lower band two standard deviations below it. Traders use them to judge whether a price is stretched relative to its recent range and whether volatility is contracting or expanding. John Bollinger created the technical analysis tool in the 1980s. In Excel, MarketXLS returns the middle band with =SimpleMovingAverage("AAPL", 20) and the standard deviation with =StandardDeviationOnClosePrice("AAPL", 20); the upper band is the average plus 2 times the standard deviation, and the lower band is the average minus 2 times it. This is educational content, not investment advice.
Overbought and oversold readings Traders use the bands to judge whether a stock is being overbought or oversold. When prices move near the upper band, the more overbought the security is and when the price reaches the lower band, the more oversold it is. Bollinger has 22 rules to follow when using this technique. Here we will discuss some of the prominent factors.**Breakouts **Breakouts are often times misunderstood by investors. The great majority of price action occurs within the two bands. Breakouts are when prices are above or below the bands; however, this does not constitute a trade action. Neither direction is a signal to buy or sell; rather the breakout is an anomaly and does not provide a path towards the future movement of the stock.Double BottomThe double bottom is a reversal pattern at the lower band. To execute the double bottom, you mark the first time the price touches the lower band, and then wait to see where the next low point occurs. A price that is near or at the low can be a sign of a buying opportunity. When the second low holds above the lower band, traders read it as possible buying interest, though the pattern can fail.
The SqueezeConsidered the most fundamental component of the Bollinger Bands, the squeeze, occurs when the bands come together narrowing the moving average. Traders consider this period a potential opportunity to make trades as a squeeze signals a time of low volatility with the expectation there is greater volatility later. When the bands widen, volatility is rising, often as a new trend or breakout gets under way.
The Classic M TopThe classic M top certainly received its name based on how the price movement creates the letter “M” on a chart. It occurs when a price soars high just before a sell-off, and then a push towards its previous high. When a chart depicts the classic M top, it is hard for traders to simply predict whether the stock is going to trend upwards or down. Many traders treat a second high that fails to close above the upper band as a sell signal.
Using Bollinger Bands Bollinger Bands can be used in several ways to determine the current volatility of a stock, its price movement in relation to its moving average, and as a way of finding a trade opportunity. It is important to remember that when the price touches the upper band that does not robotically mean to sell. This also goes for prices touching the lower band, not automatically displaying a buy signal. On occasions, the price may break out of the upper band and if you sold once the price touched the upper band, then you have missed out on profits. Sometimes it is wiser to wait for a double bottom or a classic M top to form to better gauge its potential trend.
Calculate Bollinger Band values with MarketXLS and plot them
Step 1) Get the historical prices in Excel.
Step 2) Select Bollinger Bands from the menu and pass the Close price values.
Step 3) Select a cell to post the results and the bollinger band series will be calculated.
Once, you have the Bollinger band series, you can simply plot it or backtest your trading strategy based on Bollinger Bands.
With MarketXLS, you can plot your Excel data and add Bollinger Bands while customizing your charts.
When the price line crosses back inside the upper or lower band after moving outside it, some traders read it as a possible reversal of the trend.
This technique can also be an indicator of beginning and ending of strong trends. Strong trends can cause a rapid increase in volatility. When bands move far apart or incredibly narrow, traders find it necessary to wait out the trend. This interim high volatility can cause major losses on trades.
A trader’s sole system of decision making is not meant to be based on Bollinger Bands. Bands work as a tool to determine price volatility and price trend analysis. Use Bollinger Bands to flag setups worth a closer look, not as a stand-alone trading system.
Since Bollinger Bands are a pure price indicator, using them with other technical analysis, such as volume indicators and market trends, will make this technique much more effective. Certainly, there is no one technique that will provide the very bottom price to buy or top price to sell. Bollinger Bands add volatility context to those other signals.
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