The next indicator that we will learn in this unit gauges the volatility of the stock known as 'Bollinger Bands'
Bollinger Bands was developed by John Bollinger. It consists of the center line and two price bands. The center line is the 20-day moving average and the two trading bands are the price volatility bands. The two outer bands are plus and minus 2 standard deviations.
How to master Bollinger Bands?
Bollinger Bands are volatility bands placed above and below a moving average. Volatility is the degree of variation of a trading price series over time as measured by the standard deviation of returns.
The bands automatically widen when volatility increases and narrow when volatility decreases.
A "W-Bottom" forms in a downtrend and involves two reaction lows. In particular, Bollinger looks for W-Bottoms where the second low is lower than the first, but holds above the lower band
An M-Top is similar to a double top. However, the reaction highs are not always equal. The first high can be higher or lower than the second high. Bollinger suggests looking for signs of non confirmation when a security is making new highs
Overbought and Oversold strategy
This is a common strategy when we trade with Bollinger Bands. This strategy is used in the trading range market, to identify overbought and oversold regions in the current market conditions. When the price of the stock or index breaks below the lower band, then the trader can buy expecting the price to return back to the middle band. Similarly, when the price of the stock or index breaks above the upper band, the trader can sell expecting the price to return back to the middle band. This strategy cannot be used in strong trending markets.
Bollinger Bands Squeeze Strategy
This is another strategy which can be used while trading with Bollinger Bands. A squeeze is formed when the prices move sideways in the consolidation.
When the prices move in consolidation the upper and lower bands come close to each other. This means that the volatility of the stock has decreased. This may not be the case always and the volatility of the stock will tend to increase again after a certain point of time. The prices make a large move in either direction after the consolidation. Increase in the volumes on a breakout is a sign that the stock is no more in consolidation and it is going to form an uptrend or downtrend.
When the price breaks the upper or lower band then the trader can buy or sell accordingly.