Bollinger Bands for Day Trading

Bollinger Bands are a pair of trading bands representing an upper and lower trading range for a particular market price. It is said that a particular security would trade within this trading range under normal circumstances. The Bollinger bands consist of moving averages on either side and are used for decisive entry and exit signals by the traders. The lines are plotted using standard deviation on either side of the moving averages. The volatile nature of the security changes the standard deviation values and thereby changes the width of these bands on either side.

Bollinger Bands can be used as a decisive trading system by investors and traders for all security classes and types. Bollinger Bands can also be used on any time frame. Bollinger bands along with the use of other indicators can be used to make decisive decision. Like when the price is nearing the upper end of the trading band with the help of an indicator like the RSI, traders can go short and when the stock is near the lower end of the trading band traders can use it as a signal to go long.

Key Features of Bollinger Bands

• ·         A move originating at the upper band tends to go all the way to the lower band and vice versa. This is generally the case for most of the securities and therefore is used extensively to enter or exit a particular trade
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• ·         Quick moves tend to happen when the Bollinger bands contract and there is less volatility in price. It is said that when prices are the least volatile, the propensity of a breakout is the highest
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• ·         At breakout, the current trend is generally sustained

Components of the Bollinger Band

• ·         Moving Average: Generally taken as 14 to 20 day moving average
• ·         Upper Band: Generally calculated as 2 standard deviation above the closing prices of the moving average
• ·         Lower Band: 2 standard deviations below the moving average

Buy & Sell Signals

Whenever the stock has hit the lower end of the Bollinger band it is a buy signal and prices generally move back towards the higher end of the trading band once they have crossed over the simple moving average in the middle. A sell signal is generated with the opposite

Rules for Bollinger Band Trading

·         Bollinger Bands are just a relative definition of a high or a low

·         These relative definitions with the use of indicators can be used to enter decisive buy and sell decisions

·         Appropriate indicators can be derived and should be used along with Bollinger Bands. For example: MACD, RSI, OBV (volume indicator) should all be used in conjunction with Bollinger bands

·         Volatility has already been used to calculate the width of the Bollinger Bands and therefore should not be used as a different indicator for buy and sell decisions

·         Use different indicators from different sets. Don’t use two momentum indicators, use one from Momentum and the other from volume if need be

·         Bollinger Bands are used to confirm pure price patterns like different types of Tops and Bottoms

·         Price generally moves within the Bollinger bands so can be up or down depending on the overall trend for long periods of time

·         Closes outside the Bollinger bands can just be a sign of continuation and not a breakout or reversal, so traders really need to use other indicators for confirming the trade entries

·         Bollinger Bands generally have a set default pattern with regards to their makeup and the standard deviation is used to as per the volatility in a particular stock

·         Non Descriptive moving averages should not be used for the creation of Bollinger bands