NOTE: I don’t use Bollinger Bands for trading but when I see many newbies using it in a wrong way, decided to write a blog on it.
In the initial days of trading career, many people are excited about indicators. They try and gain as much as information they could on indicators. They get fascinated over how they work. Trying every indicator and see if it works with your strategy is everyday task for them. Some of the indicators are popular and some are more than popular, among which come the Bollinger Bands developed by John Bollinger.
Bollinger Bands (BB) consist of 3 lines: A simple moving average (Middle Band), and Upper and Lower Band. The upper and lower bands are typically 2 standard deviations +/- from a 20-day simple moving average, but can be modified. This is all the information about BB you are going to need. No need to go in details of calculations as it is not useful at all. I will share some insights on how it works, what are the uses of it? Please remember that I will not be sharing any strategy whatsoever. Because indicators should only be used for confirmation & not as a strategy. If indicators were to make money, then trust me, every indicator developer would be the richest person on earth. My only attempt will be to simplify BB so that you can understand it better.
BB is very useful who likes volatility. Many traders thrive on volatility and has their own way around it. BB is an indicator which helps you find volatility in any given script. How? We will see below…
There’s a concept of ‘coil breakout’ in stock market. Which means when an instrument trades in a very tight range for some period, it tends to breakout with sharp moves. Just like a spring. If you press a spring from both ends, and when you release the pressure, it just pops out. If you apply the same principle and find some stocks with tight range, you may able to capture good moves. When upper and lower bands are wider then the volatility is more and when it’s narrower then it’s waiting for the volatility to come. See below image for reference, because a picture speaks louder than words…
(Tata Steel, 5 min)
Notice the highlighted areas in the chart. See how the price is in a tight range before moving further. All you have to do is identify a trend of market. Here, Tatasteel is in an uptrend. When the price makes a higher low, keep watching the stock and see if the BB is making an narrow range. Once the breakout happens, you can ride the trend. Same can be done in a downtrend too. See below image…
(Eicher Motors, 1H)
In the above image, Eicher motors is in a downtrend, notice the highlighted range and its consequences.
Bollinger Bands give you a signal before volatility so that you can be prepared when the actual movement comes. You can check as many stocks as you want for study purpose. But again, you have to have a decent knowledge of price action first to incorporate a strategy around any indicator. Because indicators are mere price shadows and that’s the reason, they are called lagging indicators. Because they follow price and/or volume. Learn price action thoroughly before using indicators.