Bollinger Bands Stocks Analysis & Bollinger Signals

Developed by John Bollinger

Bollinger bands are formed by three lines. Middle line is a Moving Average - 20 period Simple Moving Average.

The bands are then drawn at a distance away from the moving average These are the bands that form the lower & upper lines.

The distance where the bands are drawn is decided by another indicator called the standard deviation. Standard deviation is a measure of volatility in the market or that of a stocks.

Since the market volatility keeps on changing, the standard deviation will keep varying, and since Bollinger bands are drawn using the standard deviation the distance of the bands will keep on adjusting themselves to the market conditions.

When the markets become more volatile, the bands widen and they contract during less volatile periods.

The 3 Bands are designed to encompass the majority of a price action. The middle band forms the basis for the trend, typically a 20-periods simple moving average.

This band also serves as the base for the upper & lower bands. The upper band's & lower band's distance from the middle band is decided by volatility. Upper band is drawn at +2 standard deviations above the middle band while the lower band is drawn at -2 standard deviationss below the middle band.

Stocks Analysis & How to Generate Signals

• Bands provide a relative definition of high and low

• Used to identify periods of high & low volatility

• Used to identify periods when prices are at extreme levels

Consolidation

The bands tighten as volatility lessens, this identifies periods of consolidation. Sharp price breakouts tend to occur after the bands tighten.

Consolidation Pattern

Continuation Signal

If stocks prices break through the upper or lower band move outside the bands a continuation of the current stocks trend is expected.

Reversal Signals

Bottoms & tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend

The Head Fake - Stocks Whipsaw

Traders should be on lookout for false breakouts known as whipsaws or head fakes.

Price often breaks out in one direction immediately following the Squeeze causing many traders to think the break out will continue in that direction, only to quickly reverse & make the true, more significant break out in opposite direction.

Traders acting quickly on the initial breakout often get caught on the wrong side of the price action, while those traders expecting a 'false breakout' can quickly close out their original position and enter a trade in direction of the reversal. It is always good to combine Bollinger bands with other confirmation Indicators.