Congratulations on making it to the 5th grade! Nor would you use a buzz saw to drive in nails. Just like in trading, some trading tools and indicators are best used in particular environments or situations. So, the more tools you have, the better you can adapt to the ever-changing market environment. For this lesson, as you learn about these indicators, think of each as a new tool that you can add to that toolbox of yours.
You might even find one that you understand and comfortable enough to master on its own. Now, enough about tools already! When the market is quiet, the bands contract and when the market is LOUD, the bands expand.
Notice on the chart below that when price is quiet, the bands are close together. When price moves up, the bands spread apart. One thing you should know about Bollinger Bands is that price tends to return to the middle of the bands.
If you said down, then you are correct! As you can see, the price settled back down towards the middle area of the bands. The reason these bounces occur is because Bollinger bands act like dynamic support and resistance levels. The longer the time frame you are in, the stronger these bands tend to be.
Many traders have developed systems that thrive on these bounces and this strategy is best used when the market is ranging and there is no clear trend. When the bands squeeze together, it usually means that a breakout is getting ready to happen. Looking at the chart above, you can see the bands squeezing together.
The price has just started to break out of the top band. Based on this information, where do you think the price will go? There are many other things you can do with Bollinger Bands, but these are the two most common strategies associated with them.
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