We will start with a brief background on its construction and then move on to the original interpretations you can apply right now in your market analysis. American financial analyst John Bollinger laid the groundwork for this powerful tool in the early s, first applying it to the options markets.
Price channels at that time kept a constant width, ignoring volatility as a major variable. Most traders expect trending action when Bollinger Bands expand and rangebound conditions when bands contract but this simplified interpretation rarely produces actionable buy or sell signals.
These organize naturally into top, center and bottom band crosses, well as relative band angles when price strikes them. The moving average denotes a central tendency point where price should return after it swings higher or lower. Standard deviation predicts how far a swing should carry based on current volatility, which is updated with each price bar.
Top and bottom bands visualize these hidden levels, which are relative to the moving average chosen for the indicator. The bar works fine in most cases, so there is no need to data mine for the perfect input.
It is a different story with standard deviation because highly emotional markets routinely push price beyond 2SDs. An effective solution is to add shadow bands at 3SD to account for these volatile conditions, which require more risk-sensitive buy and sell signals.
You can see an additional layer of information with Tesla Motors TSLA in the summer of when it rallied to an all-time high. Although the stock pierced the 2SD band repeatedly, 3SD held the trend in each instance, providing reliable clues on reversals and waning momentum.
This highlights the natural symbiosis between these indicators. Bollinger Bands show their greatest power when price rises into the top band or descends into the bottom band. The shifting relationships between price, bandwidth and band-angle generate an assortment of patterns that emit unique short-term price predictions.
Generally speaking, expect bands to hold back price when they remain horizontal into a cross or slope against price direction. These are called rising or falling box patterns. These emit flower patterns, evoking the image of flower petals opening to the energy of sunlight.
Bollinger Bands contract, as a new trading range develops, yielding a crossover with the rising bottom band 1 in November. This falling box pattern holds, triggering a reversal that generates a top crossover into a contracting band 2 a few weeks later. This rising box pattern holds as well. This predicts an impending reversal that combines with support at the top of the October gap, even though the bottom band opens on the second bar.
This is common behavior because the price pattern has greater impact on short-term direction than shifting volatility. The top cross 4 in January carves an upside down version of the December failure, with a slight upward turn that runs straight into resistance at the October top.
In both cases, timely reversal bars forced Bollinger Bands back toward the horizontal, re-establishing the rangebound box for another round of two-side action. Fully opened bands with price moving easily along its edges create stairstep patterns, denoting stable trends that may continue for an extended period. Thrusts outside the band, reaching toward 3 and even 4SD signify overheating, commonly associated with a climax pattern that predicts a pause in the trend or outright reversal.
It descends day after day in September and October, touching but rarely piercing the bottom band. A deeper penetration mid-month red rectangle triggers an immediate retracement that stalls exactly at the day SMA mean reversion level.
The stock resumes its downward trajectory into November and enters a retracement that spends another seven days reverting to mean. A quick pop into the declining top band blue rectangle sets off a rising box reversal as expected, yielding more downside into December.
Once again, it pops to the day SMA, spending more than two weeks at that level, before plunging into the 3SD bottom band and completing a climax pattern that triggers another reversal green rectangle.
The Bollinger Band analysis works extremely well when applied to two time frames at once. For example, focus on relatively rare strikes at top, center and bottom weekly bands, using those levels for buy or sell signals when daily bands line up in similar patterns. The Illumina ILMN weekly chart shows a month trading range that ends right after the stock pierces the horizontal bottom band, triggering a weekly falling box reversal.
The initial trend wave ends at the top band, yielding the sideway pattern highlighted in a prior example. Note how the two falling box reversals highlighted on the daily chart began at the week SMA. Finally, the top weekly band is lifting up and away from price bars, completing a bullish flower pattern that predicts an eventual breakout.
Bollinger Bands have become an enormously popular market tool since the s but most traders fail to tap its true potential. You can overcome this deficit by organizing price-band relationships in multiple time frames into repeating patterns that predict specific short-term price behavior. Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews.
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Become a day trader. Fine Tuning Standard Deviation It is a different story with standard deviation because highly emotional markets routinely push price beyond 2SDs. Box and Flower Patterns Bollinger Bands show their greatest power when price rises into the top band or descends into the bottom band. Stairstep and Climax Patterns Fully opened bands with price moving easily along its edges create stairstep patterns, denoting stable trends that may continue for an extended period.
Multiple Time Frames The Bollinger Band analysis works extremely well when applied to two time frames at once. The Bottom Line Bollinger Bands have become an enormously popular market tool since the s but most traders fail to tap its true potential.
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