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. John Bollinger developed this trading technique. He was a famous technical trader who developed the Bollinger Band strategy to find volatility.
What Are Bollinger Bands?
Bollinger Bands are a popular indicator that traders use to help determine overbought and oversold levels. Many traders also like using RSI. Bollinger Bands give more of a visual view, so it depends on which indicator you prefer. They contract when volatility decreases. As a result, any moves that happen outside of the bands are seen as significant.
Bollinger band trading is popular. Many traders consider the market overbought as the price moves toward the upper band and oversold as the 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 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 the price trades within the trend lines you’ve drawn.
It gives you more information about what a stock or the market is doing. Bollinger bands are like rubber bands. If the price trades outside of them, it will snap back.
Bollinger Bands Example
This is an example of how Bollinger Bands look within the ThinkorSwim platform. This is on a 5-minute chart. At that time, the market’s open price action formed a rising wedge that hit the Bollinger bands’ top. Then, the price pulled back and ultimately failed. It created a large falling wedge pattern during the power hour that traded sideways into the after-market hours.
Using Bollinger Bands Trading
Bollinger band trading is among the most commonly used and useful strategies. Traders use the bands as buy and sell signals for volatility.
Using the bands for momentum trading allows you to capitalize on the move out of the bands and the upcoming momentum. This can be a really useful strategy when you’re day trading options.
You want to get in on the volatility if you’re using penny stock strategies. There are a couple of strategies, such as the squeeze and breakouts, where the bands are primarily used.
The Squeeze
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 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, you know no crystal ball lets you know what a stock will do. There are other factors like volume and patterns.
Breakouts
If you use them in trading, you’ll notice that 90% of the action occurs within the bands. Any breakout, whether above or below, is a pretty big deal.
Some traders primarily trade Bollinger band breakouts. However, just because the price breaks out of the bands doesn’t mean it’s a buy or sell signal.
That’s a mistake many people can make when trading with Bollinger bands. Just because the price breaks out doesn’t mean it will continue in that direction.
Final Thought on Bollinger Bands
Bollinger bands aren’t a trading strategy that can be used alone. It would be best if you had 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. To use them correctly, you must add several other indicators. Then, you can scalp trades within the bands as well.
