Another pattern of note is a Bollinger Band “squeeze.” This occurs when volatility reaches a relative low in the context of recent price action. This squeeze can frequently be followed by a period of increased volatility, and may result in a significant move by the stock to the upside or the downside. There are times, however, when the strategy is correct, but the selling pressure continues. During these conditions, there is no way of knowing when the selling pressure will end. Therefore, a protection needs to be in place once the decision to buy has been made.

Unlike a percentage calculation from a normal moving average, bollinger bands® simply add and subtract a standard deviation calculation. Bollinger Bands® gives traders an idea of where the market is moving based on prices. Because Bollinger Bands® are computed from a simple moving average, they weigh older price data the same as the most recent, meaning that new information may be diluted by outdated data. Also, the use of 20-day SMA and 2 standard deviations is a bit arbitrary and may not work for everyone in every situation.

Riding the Band Downward

To help remedy this, a trader can look at the overall direction of price and then only take trade signals that align the trader with the trend. For example, if the trend is down, only take short positions when the upper band is tagged. The lower band can still be used as an exit if desired, but a new long position is not opened since that would mean going against the trend.

• As the chart above shows, this is not the case for the S&P 500 as the bands have actually widened a bit since mid-December 2022.
• The variance itself is the average of the squared differences of the mean (the simple average of a given set of numbers).
• The next trading day was not until December 26, which is the time when traders would enter their positions.
• Since Keltner Channels use average true range rather than standard deviation, it is common to see more buy and sell signals generated in Keltner Channels than when using Bollinger Bands®.
• If the price deflects off the lower band and crosses above the 20-day average (the middle line), the upper band comes to represent the upper price target.
• The number of standard deviations, in turn, determines the distance between the middle band and the upper and lower bands.

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History of Bollinger Bands

While the two indicators are similar, they are not exactly alike. Chart 6 shows Air Products (APD) with a surge and close https://www.bigshotrading.info/blog/forex-trading-sessions/ above the upper band in mid-July. First, notice that this is a strong surge that broke above two resistance levels.

A double bottom occurs when there is a fall in price, followed by a rise, followed by another fall that is close to the previous low, and finally another rise. The second high must not be higher than the first one, and the second high mustn’t touch or spike the upper band. Another example of a successful attempt using this strategy is found on the chart of the New York Stock Exchange when it broke the lower Bollinger Band® on June 12, 2006. Below is an example of how this strategy works under ideal conditions. This strategy is designed for you to catch a move as early as possible.

Day Trading Uptrends With Bollinger Bands

Using the bands as overbought/oversold indicators relies on the concept of mean reversion of the price. Mean reversion assumes that, if the price deviates substantially from the mean or average, it eventually reverts back to the mean price. John Bollinger used the M patterns with Bollinger Bands to identify M-Tops. In its basic form, an M-Top is similar to a Double Top chart pattern.

The downtrend can last for short or long durations – either minutes, hours, weeks, days, months, or even years. Investors must identify any sign of downtrends early enough to protect their investments. If the lower bands show a steady downtrend, traders must be cautious to avoid entering into long trades that will prove unprofitable. By default, the overlay uses a 20-period SMA and sets the bands 2.0 standard deviations above or below the SMA. These parameters can be adjusted to meet your technical analysis needs. Various studies of the effectiveness of the Bollinger Band strategy have been performed with mixed results.

There are multiple uses for Bollinger Bands®, including using them for overbought and oversold trade signals. Traders can also add multiple bands, which helps highlight the strength of price moves. Another way to use the bands is to look for volatility contractions. These contractions are typically followed by significant price breakouts, ideally on large volume.