Using Bollinger Bands to Gauge Trends

Many traders avoid trading during downtrends, other than looking for an opportunity to buy when the trend begins to change. The downtrend can last for short or long durations – either minutes, hours, weeks, days, months, or even years. Investors must identify any sign of downtrends early enough to protect their investments. If the lower bands show a steady downtrend, traders must be cautious to avoid entering into long trades that will prove unprofitable. Bollinger Bands can be used to determine how strongly an asset is rising and when it is potentially reversing or losing strength. If an uptrend is strong enough, it will reach the upper band regularly.

When using Bollinger Bands®, designate the upper and lower bands as price targets. If the price deflects off the lower band and crosses above the 20-day average (the middle line), the upper band comes to represent the upper price target. In a strong uptrend, prices usually fluctuate between the upper band and the 20-day moving average. When that happens, a cross below the 20-day moving average warns of a trend reversal to the downside. Because Bollinger Bands® are computed from a simple moving average, they weigh older price data the same as the most recent, meaning that new information may be diluted by outdated data. Also, the use of 20-day SMA and 2 standard deviations is a bit arbitrary and may not work for everyone in every situation.

  1. John Bollinger suggests using them with two or three other non-correlated indicators that provide more direct market signals and indicators based on different types of data.
  2. ●     Bollinger Bands do not provide unambiguous recommendations on their own.
  3. The bands are composed of different lines that are plotted on a chart, including the moving average, an upper band, and a lower band.
  4. However, Bollinger Bands—especially when paired with other indicators such as chart pattern recognition tools—can help you make better trading decisions.

An uptrend that reaches the upper band indicates that the stock is pushing higher and traders can exploit the opportunity to make a buy decision. One of the main limitations is that it shouldn’t be used as a standalone tool. In avatrade review fact, Bollinger Bands® should be used with other non-correlated indicators. Doing so may give you additional market signals that are much more direct. Another drawback is that they are calculated using a simple moving average.

Using Bollinger Bands as Support and Resistance Levels

As such, the 10-period Commodity Channel Index (CCI) was used to identify short-term overbought situations. A move back below +100 signals a resumption of the downtrend (red arrows). In a classic M top, the first high either touches or is outside of the upper band, the price reacts by dropping close to the middle band (the moving average), and the second high touches inside the upper band. The fact that the second high is within the upper band suggests that it is a lower high on a relative basis.

Day Trading Downtrends With Bollinger Bands

It involves the use of three bands—one for the upper level, another for the lower level, and the third for the moving average. When prices move closer to the upper band, it indicates that the market may be overbought. Conversely, the market may be oversold when prices end up moving closer to the lower or bottom band. A stock may trade for long periods in a trend, albeit with some volatility from time to time.

What Do Bollinger Bands® Tell You?

Bollinger uses these various M patterns with Bollinger Bands to identify M-Tops, which are essentially the opposite of W-Bottoms. According to Bollinger, tops are usually more complicated and drawn out than bottoms. Double tops, head-and-shoulders patterns, fxtm review and diamonds represent evolving tops. The information here is for general informational purposes only and should not be considered an individualized recommendation or endorsement of any particular security, chart pattern or investment strategy.

Therefore, only small adjustments are required for the standard deviation multiplier. An increase in the moving average period would automatically increase the number of periods used to calculate the standard deviation and would also warrant an increase in the standard deviation lexatrade review multiplier. With a 20-day SMA and 20-day standard deviation, the standard deviation multiplier is set at 2. Bollinger suggests increasing the standard deviation multiplier to 2.1 for a 50-period SMA and decreasing the standard deviation multiplier to 1.9 for a 10-period SMA.

If you’re looking to go long when trading a squeeze, consider placing a buy entry point above the upper band. Once it’s executed, you could place an initial stop under the low of the breakout formation or under the lower band. Remember to adjust your stop orders as needed, or consider using a trailing stop designated in either a fixed dollar amount or a fixed percentage.

Commodity and historical index data provided by Pinnacle Data Corporation. The information provided by StockCharts.com, Inc. is not investment advice. The stock moved above the upper band in April, followed by a pullback in May and another push above 90. Even though the stock moved above the upper band on an intraday basis, it did not CLOSE above the upper band. Additionally, the MACD formed a bearish divergence and moved below its signal line for confirmation. They can be used to identify M-Tops and W-Bottoms or to determine the trend’s strength.

Bollinger Bands ® Explained – The Best Trading Indicator

However, the reaction highs are not always equal; the first high can be higher or lower than the second high. Bollinger suggests looking for signs of non-confirmation when a security is making new highs. Third, prices move above the prior high but fail to reach the upper band. The inability of the second reaction high to reach the upper band shows waning momentum, which can foreshadow a trend reversal. Final confirmation comes with a support break or bearish indicator signal.

In this example, the market just briefly poked above the higher Bollinger Bands ® and then immediately was rejected. Such a quick rejection move can be seen as a rejection of the bullish buying attempt. If such a rejection is followed by a strong bearish candle, this sequence may foreshadow more selling to come. In the screenshot below, the price first showed a Bollinger Bands ® exhaustion.

Finally, the Bollinger Bands ® started contracting and the bands narrowed when the price started moving sideways with smaller candlesticks. A bullish trend change might now be underway when the price starts pushing into the upper Bollinger Bands ®. An important requirement for the correct use of the indicator is sufficient price activity and calibration of the parameter settings based on the history of its movement.

The ability to hold above the lower band on the test shows less weakness on the last decline. Fourth, the pattern is confirmed with a strong move off the second low and a resistance break. Developed by John Bollinger, Bollinger Bands® are volatility bands placed above and below a moving average.

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