Anyone looking to engage in asset trading needs to have a basic grasp of technical indicators. Through these indicators, one can determine market sentiment or even distinguish between long-term patterns.
One of the most commonly used tools is Bollinger Bands. It is a very strong indicator that can be used for many different purposes.
The Purpose of Bollinger Bands
Technical indicators are often named after the person who came up with the technique. Bollinger Bands were first made “famous” by John Bollinger. Since their introduction in the 1980s, they quickly became one of the most commonly used technical indicators. Bollinger Bands work for any asset or market, regardless of timeframe.
The shape created by BBs includes two deviation lines based on a simple moving average of the asset’s price. One deviation line is positive, whereas the other is negative. Depending on market conditions, these lines can be close to or very far apart from the simple moving average.
When the BBs widen, there is often more market volatility and liquidity. Volatility does not necessarily indicate a decline in asset price either. Market shifts can easily occur in any direction.As such, these deviations often measure the current and previous volatility of a chart’s timeframe. This can, in turn, be used to potentially discover market trends.
What can we Learn From Them?
Knowing what Bollinger Bands indicate is only the first step. Interpreting the information is often the hardest part. The most obvious use case for BBs is to determine when periods of volatility may ensue. This can often be gauged by the shape of the BBs in question.
If the bands contract, a “squeeze” occurs. This is often a sign of the price remaining relatively close to the simple moving average. Low volatility periods like these are often a precursor to a major market shift.
Contractions can last anywhere from a few hours up to several weeks or even months. They often tend to occur after the bands have been wide open for an extended period of time.
Another event to look out for is a breakout. This indicates a time during which the price breaks out over the Bollinger Bands themselves. Such action is relatively rare, but it can occur in more volatile markets. Breakouts can occur in either an upward or downward direction.
Despite all of this, a BB on its own is never a clear trading signal. It is merely a tool to be used in conjunction with other indicators to form a comprehensive picture. On their own, the BBs hardly ever offer an indication as to which direction a market may move in.