Regina, SK Canada (PressExposure) February 28, 2012 -- The method of taking a moving average with a couple of trading bands above and below it was created by John Bollinger (an experienced market technician ) in the 1980s.
Unlike a percentage forecast from a regular moving average, Bollinger bands [http://iticsoftware.com/metatrader-indicator-bollingerbands-div] simply add and deduct a standard deviation calculation.
Standard deviation is a very exact formula which shows the degree to which the price of a stock will vary from its correct price.
By measuring price instability, Bollinger bands alter themselves to market situations.
Traders find them so useful for this reason: this tool is able to show almost the entire price data needed in between the 2 bands.
So what is a Bollinger Band?
Bollinger Bands are made up from the centre line as well as its respective upper and lower price bands.
The centre is an exponential moving average; the price channels are the normal distortions of the stock being analysed.
These bands will increase and get tighter as the stock price becomes less stable (expansion) or can become bound into a tighter trading pattern (contraction).
It's usual for a stock to transact over a long period, but may show some instability once in a while.
Traders will organise the price activity using the moving average to make it easier to spot the pattern.
This way, dealers are able to gather the key data as to exactly how the market is selling and buying.
As an example, should a trend rise or drop sharply, the market can solidify so trading a in a tighter trend and moving above and below the moving average.
To make it easier to follow these actions, traders utilise price channels, as this will include all of the trend's trades.
It's known that markets deal in a volatile manner on a daily basis despite the overall picture showing an upward or downward direction.
Market technicians will use moving averages together with support and resistance bands to anticipate a stock's price activity.
The higher resistance and low support lines will be created initially and so plotted to create bands inside which the dealer will look to estimate the prices that will be included.
Some dealers will draw lines directly that join the higher lines to the lower ones of the price so as to identify the extreme upper or lower limits of the price then include parallel lines to mark the channel where prices should change within.
While prices don't stray outside this channel, traders will feel comfortable that prices are moving as planned.
Prices are deemed to be overbought once they regularly touch the upper Bollinger Band.
Conversely, by continually meeting the lower band, the prices are seen as oversold, triggering a signal to buy.
When using Bollinger bands, price goals can be set by assigning the upper and lower bands.
Assuming that prices move away from the lower band and over the middle line (20 day average), the upper band will represent the upper price target.
Prices will tend to vary between the upper and 20-day moving average in a strongly upward trend.
As this happens, the cross-point beneath the 20-day moving average signals that the trend could start moving down.
Not to say that Bollinger Bands aren't highly viewed as being able to gauge oversold or overbought stocks, but it would be prudent to first of all recognise trends and then simple moving averages prior to progressing onto more exciting signals.
The Key Message
Although all approaches have their disadvantages, Bollinger Bands are now one of the more useful and often used tools to help spot excessive short-term stock prices.
Buying at the point a stock price goes under the lower band often gives the trader a chance to really gain from oversold situations and profit when the price of the stock heads back up towards the centre moving-average line.
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