Bollinger Bands are a technical indicator created by renowned technical trader John Bollinger in the early 's. There are numerous publications, as well as John's website www.
This article will touch on the basic parameters of Bollinger Bands and how they may be used in options trading. Bollinger Bands are considered to be a volatility indicator, similar to the Keltner channel indicator. Their purpose is to provide traders a relative definition of highs and lows. This means that prices are high at the upper band, and low at the lower band. Bollinger Bands can help recognize price patterns, and can be useful to traders of all levels in their trade entry, management and exit strategies.
The Bollinger Bands study as shown on Thinkorswim consists of two lines plotted, two standard deviations above and below a moving average. The standard deviations can be changed based on a trader's choice, as can the other settings will are explained below. The standard deviation lines change as price and volatility goes up or down. The upper band can indicate an overbought level, while the lower band can indicate an oversold level. However, as we have all seen at times, if prices approaches either band, or bounces off, it is not a guarantee of a breakout or reversal.
The way traders interpret and use Bollinger Bands varies, depending on the individual and trading style. Some choose to buy when price touches the lower Bollinger Band, and close the position when the price rebounds to touch the moving average center line. Others may choose to go long when price breaks out above the upper Bollinger Band, or go short if the price falls below the lower band.
It is also worth noting that the use of Bollinger Bands is not limited to stock traders. Because the Bollinger Bands indicator is a volatility study, some options traders sell options when the bands are spread apart, or buy options when the bands are close together. In both of these cases, the trader is expecting volatility to retrace to the average historical volatility level for that particular underlying.
When the Bollinger Bands are close together, it usually indicates a period of low volatility. On the other side of the coin, as the bands expand and move farther apart, an increase in volatility is indicated. Lastly, when the bands only have a slight slope and track fairly even for a period of time, it indicates that the price of the underlying may continue to channel in between the bands.
Many traders also like to use Bollinger Bands in conjunction with other indicators to confirm price action, such as a trendline. If the trendline confirms the movement suggested by the Bollinger Bands, the trader may have more confidence that the bands are predicting a correction in the price action in relation to market volatility.
Subsequent articles will cover more technical indicators widely used by traders of all levels. Become a part of Capital Discussions. It is free and informative… https: Joanna has been trading options full time for income for 9 years and resides in the US. After a diverse career in marketing and sales management, she chose trading as her full-time career. Joanna primarily trades non-directional, positive theta trades such as Iron Condors and Butterflies.
Her trade plan consists of a combination of monthly and weekly trades. Risk management is of the utmost importance to Joanna. She looks to take smaller, consistent gains and control losses carefully to achieve her annual income goals.
Your email address will not be published. Our Email Addresses Support: Add to your address book. Apple iTunes Audio Podcast. Your Privacy is protected. The default settings in the above Think or Swim chart are shown below: Thinkorswim's Default Bollinger Band Settings Close This represents the price which is used to calculate the moving average and the standard deviation.
Depending on which charting software is being used, traders can choose other parameters such as open, volume, etc. TOS' default setting of zero is preferred by many traders. In this case 20 is the day simple moving average. How do traders use Bollinger Bands? It is a great community with traders who are always willing to share and help each other. Leave a Reply Cancel reply Your email address will not be published.More...