Bollinger bands are also known as volatility bands. Any move that happens outside of them is significant. Stocks are like rubber bands that want to pull back to equilibrium levels. The bollinger band setup has two volatility bands that bracket a moving average line. The bands get wider as volatility increases. This trading technique was developed by John Bollinger. He was a famous technical trader who developed the bollinger band strategy to find volatility.
What Are Bollinger Bands and How Do They Work?
- Bollinger Bands are a popular indicator that traders use to help determine overbought and oversold levels. Many traders also like using RSI. Bollinger Bands gives more of a visual view, so it’s all a matter of preference which indicator that you prefer.
The stock market is a tug of war between buyers and sellers. As a result, traders are looking for tools to give them the upper hand. The goal of every trader is to make money (try our stock picks free).
In order to do that, you want to use the tools at your disposal. In essence, there are many tools for you to choose from. However, you don’t want to have too many.
In order to make sure you aren’t using too many trading tools, open a practice account and find what works best for you. Read our post on how to open a brokerage account.
Basics of Bollinger Bands
They contract when volatility decreases. As a result, any moves that happen outside of the bands are seen as pretty significant.
Bollinger band trading is really popular. In fact, many traders consider the market to be overbought the more price moves towards the upper band and oversold as price moves to the lower band.
You can even look at the bollinger bands as a price channel that stocks trade inside. Price channels are used to see movement within a trend. In other words, price channels are basically trend lines within trend lines.
If that seems confusing, it’s like drawing your trend lines to see what direction a price is trading. Then you can add the bollinger band technique to see how price is trading within the trend lines you’ve drawn.
It gives you more information as to what a stock or the market is doing. Bollinger bands are like rubber bands. If price trades outside of them, it’s going to snap back (bookmark our penny stocks list and stock watch lists pages).
You can see how price traded within the bollinger bands with NVDA. You can see based off RSI that it was oversold as price was touching the upper band. This gives credence to traders beliefs that the closer price is to the bands the more overbought or oversold a stock is.
Bollinger band trading is on the the most commonly used and useful strategies out there. Traders use the bands as buy and sell signals for volatility.
Using the bands for momentum trading allows you to capitalize on move out of the bands as well as upcoming momentum. This can be a really useful strategy is you’re day trading options for income.
If you’re using penny stock trading strategies then you definitely want to get in on the volatility. There are a couple strategies such as the squeeze and breakouts where the bands are primarily used.
The Squeeze of Bollinger Bands
The bollinger band squeeze is the main concept for using them. The squeeze occurs when the bands move together to constrict the moving average.
The squeeze lets traders know that volatility has decreased. It’s also a signal that volatility is coming. Hence the squeeze has traders watching like a hawk for entry.
The opposite is also true. The more the bands widen, the greater the chance of volatility decreasing. As a result, traders view this as a sell signal.
However, the squeeze isn’t actually a buy or sell signal. Instead it’s a guide. The bands aren’t telling you when a move is going to happen. If you’ve traded for any period of time, you know there’s no crystal ball that lets you know what a stock still do.
There are other factors like volume and patterns. Read our post on stock volume. Also, if you’re looking to learn stock trading then make sure to take our free stock online courses and check out our trading service.
If you use them in your trading, you’ll notice that 90% of the action takes place within the bands. Any breakout, whether above or below, is a pretty big deal.
In fact, there are traders who primarily trade bollinger band breakouts. However, just because price breaks out of the bands doesn’t mean it’s a buy or sell signal.
That’s a mistake a lot of people can make when trading with bollinger bands. Just because price breaks out, doesn’t mean that it’s going to continue in that direction.
Price was breaking out of the bands on NFLX during premarket. When the market opened, Netflix had about 5-10 minutes of trading outside of the bands. Knowing that price would have to get back inside the bands, you could have taken a short position and rode price down.
Bollinger bands aren’t a trading strategy that can be used alone. You need some other indicators to confirm moves. RSI and MACD as well as moving average lines can and should be used.
Bollinger bands were created to find opportunities and give you a higher probability of success. In order to use them correctly, you have to add a couple other indicators. Then you can scalp trades within the bands as well.