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In the s, John Bollinger, a long-time technician of the markets, developed the technique of using a moving average with two trading bands above and below it. Standard deviation is a mathematical formula that measures volatility , showing how the stock price can vary from its true value. This is what makes them so handy for traders; they can find almost all of the price data needed between the two bands.
The centerline is an exponential moving average ; the price channels are the standard deviations of the stock being studied. The bands will expand and contract as the price action of an issue becomes volatile expansion or becomes bound into a tight trading pattern contraction. A stock may trade for long periods in a trend , albeit with some volatility from time to time.
To better see the trend, traders use the moving average to filter the price action. This way, traders can gather important information about how the market is trading. For example, after a sharp rise or fall in the trend, the market may consolidate , trading in a narrow fashion and crisscrossing above and below the moving average. To better monitor this behavior, traders use the price channels, which encompass the trading activity around the trend. We know that markets trade erratically on a daily basis even though they are still trading in an uptrend or downtrend.
Calculate Bollinger Bands using Excel
Technicians use moving averages with support and resistance lines to anticipate the price action of a stock. Upper resistance and lower support lines are first drawn and then extrapolated to form channels within which the trader expects prices to be contained. Some traders draw straight lines connecting either tops or bottoms of prices to identify the upper or lower price extremes, respectively, and then add parallel lines to define the channel within which the prices should move.
As long as prices do not move out of this channel, the trader can be reasonably confident that prices are moving as expected. If the price deflects off the lower band and crosses above the day average the middle line , the upper band comes to represent the upper price target. In a strong uptrend, prices usually fluctuate between the upper band and the day moving average. When that happens, a crossing below the day moving average warns of a trend reversal to the downside. In a couple of instances, the price action cut through the centerline March to May and again in July and August , but for many traders, this was certainly not a buy signal as the trend had not been broken.
In the chart of Microsoft Corporation Nasdaq: MSFT above , you can see the trend reversed to an uptrend in the early part of January, but look at how slow it was in showing the trend change. Bollinger Bands. Advanced Technical Analysis Concepts. You can also say that the first decline stops at the lower line red arrow. However, upon closer inspection, a slight overlap is noticeable. This once again confirms the fact that in real trading you will rarely come across perfect shapes.
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The first part of the head and shoulders formation is ideally an M-top consisting of a left shoulder and a head. Most often it is expressed in the form of an M15 or M16 shape. The next part is also an M and it includes the head and right shoulder possible shapes are M3, M4, M7 and M8. The last phase right shoulder and reverse growth before the final decline can be formed in the form of an M1 or M3 shape. M-tops are useful for identifying the tops of sustainable trends.
In the process of their formation, there is a reversal of the price movement, which opens up opportunities for effective entry into the market. Even more useful is the analysis of the interaction of the head and shoulders with the BB. It allows you to recognize the pattern before it is fully formed, which means opening a position at one of the high points and increasing the final profit from the trade.
At the same time, starting from the right dip after the head, the structure has a downward slope. This means it can be analyzed using W shapes. Reverse growth often forms as W1 or W2 shapes. As you analyze, you can get deep into the details by identifying each component of the M and W at the following levels. There should be five of them in total. But with traditional analysis, there is no need to analyze all the constituent figures. It is enough to find a few of them.
In addition, the formation is easy to read visually, as well as in terms of its interaction with Bollinger Bands and the impact on trading volumes.
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In addition to the classic head and shoulders, you will often see a variation of this pattern, which Bollinger calls the three pushes to a high. It usually completes larger shapes. When analyzing this structure using Bollinger Bands, you can see the following patterns:. Then the activity gradually decreases and in the final stage reaches a low. Let's take a look at an example. The peaks of the three pushes to a high are labeled with numbers. We will use them as serial numbers. The first push naturally crosses the upper Bollinger band.
The second creates a new top. However, it is only slightly higher than the previous one. Because of this and as a result of the previous rapid upward movement, the second pattern is not realized. The third spike is also not much stronger than the previous ones. Its high touches the Bollinger band, but the end point of the candlestick is below it. A gradual decrease in volumes from the beginning of the formation to its end confirms an early reversal. I marked this phenomenon in the chart with a blue line.
Bollinger Bands ®: The Definitive Guide (Strategy Included)
In this section, I have collected the most popular Bollinger Bands strategies. We will look at various methods within the day, in the lowest timeframes, learn how to squeeze the bands and use their signals in conjunction with other indicators. I will separately talk about the Bollinger Bands strategies, which involve trend following in the presence of a breakout of important levels and additional reversal signals.
This method appeared as a result of the efforts of the exchange analyst Kathy Lien. How to Make Big Profits in the World of Forex, she described an unusual technique involving the use of two Bollinger Bands of the same type in the same chart.
How to use Bollinger Bands?
To understand what this is about, let's add them to the chart. The first indicator will be with a period of 20 candles and two standard deviations. For the second indicator, we use slightly different Bollinger Band settings: a bar period and one standard deviation. The price being in the buy zone indicates the strength of the current trend. This means that there is a high probability that the price will go up for some time. For trend trading, Ketty recommends opening long positions when the close of the candlestick hits the upper quarter of the double Bollinger indicator.
In this case, the two bars preceding it should close in the neutral half. Keep a long position as long as the candles close within it.