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A Complete Guide to Understanding Bollinger Bands

21 Aug 2023

Introduction

Whether you are looking to catch momentum before the price actually rises, or are seeking to safeguard your money and exit positions before the market falls, technical indicators play a decisive role. Technical indicators can be helpful in identifying outcomes to make informed decisions.

Many analysts and traders combine technical indicators along with candlestick patterns to get their trades right. Markets are volatile, and to identify opportunities correctly, you need to use indicators like Bollinger bands. Let's learn what Bollinger bands are, how they work, and what are the pros and cons of including them are in your trading strategy.

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What are Bollinger Bands?

Bollinger bands are named after their inventor John Bollinger, who was a technical options trader in the 1980s. This indicator helps traders to understand market volatility and decide the right time to enter into a trade.

Bollinger bands are made up of three lines that move on the chart. One of them is the simple moving average. The other two are standard deviation lines, which are traced above and below the SMA line.

While there were other indicators involving bands, John Bollinger selected standard deviation to create this indicator. He did this to identify market volatility and was able to do it successfully. Hence, this indicator became widely accepted.

How do Bollinger Bands work?

This indicator has three bands, where

  • The middle band is based on the 20 or 21-day simple moving average of the stock’s prices.
  • The upper band is two standard deviations above the simple moving average line.
  • The lower band is two standard deviations below the simple moving average line.

The width between the upper band and the lower band of a Bollinger band is used to identify market volatility.

  • The more the width, the higher the volatility, and the lesser the width, the lesser the volatility.
  • Whenever the candlestick goes above the upper band, the stock is in the overbought area.
  • When the candlestick goes below the lower band, the stock is in the oversold area.
  • When it is in an oversold area, you can pair your indicator with chart patterns to identify positions of interest.

What are the Pros of Using Bollinger Bands?

  • Bollinger bands can protect you from buying stocks in the overbought region when the candlestick rises above the upper band.
  • This indicator is quite powerful in determining entry and exit points if it is used with proper charting techniques.

Conclusion

Protecting yourself against volatility is the best way to ensure a longer and more profitable trading career. After understanding Bollinger bands, you can save yourself from volatile market conditions and make consistent profits by identifying the correct opportunities.

 

Related Articles: Understanding Shooting Star Candlestick Pattern | What Are Momentum IndicatorsFactors to Consider When Opening a Demat Account | What is trading on equity

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