The Bollinger Bands, developed by John Bollinger is a very simple and practical technical analysis indicator designed by the US stock market analyst John Bollinger based on the standard deviation principle in statistics. Generally speaking, the movement of stock prices always changes around a certain value (such as moving average, cost line, etc.) within a certain range. The Bollinger Bands Index is based on the above conditions and introduces the concept of "stock price channel". It believes that the width of the stock price channel changes with the magnitude of the stock price fluctuation, and the stock price channel has variability, and it will automatically adjust with the change in stock price. Because of its flexible, intuitive and trendy characteristics, the BOLL indicator has gradually become a popular indicator in the market widely used by investors.
Among all the index calculations, the method of the Bollinger Bands is one of the most complicated, which introduces the concept of standard deviation in statistics, involving the middle line, the upper line and the lower line calculation. Taking the calculation of daily BOLL indicators as an example, the calculation method is as follows.
Middle band = N-day moving average
Upper band= middle band+ 2 x standard deviation
Lower band = middle band -2 x the standard deviation
The three lines and market trends
1. When the upper, middle and lower line of the Bollinger Bands run upwards at the same time, it indicates that the bullish trend of the stock price action are very obvious. The stock price will continue to rise in the short term, and investors should firmly hold the stock or build their positions.
2. When the upper, middle, and lower lines of the Bollinger Band run downward simultaneously, it represents a bearish market signal. The stock price will continue to fall in the short term, and investors should wait to build their positions or sell immediately.
3. When the upper rail line of the Bollinger Band runs downward, while the middle and lower lines are still running upward, it indicates that the security price is in a consolidation situation. It doesn’t matter if the previous market is in an strong uptrend or downtrend, this trend may slow down and new trend is yet to be decided. At this stage, investors should wait.
4. If the upper line of the Bollinger Band runs upward, while the middle and the lower line run simultaneously downward, indicating that the stock price will experience a round of decline, and the magnitude of the decline will be determined by the size of the opening. On the contrary, when the lower rail of the Bollinger Band runs downwards, while the middle and upper rails run upwards at the same time, it indicates that the stock price will experience a round of rise, and the magnitude of the rise will be determined by the size of the opening.
How to use Bollinger Band
If the price is higher than the moving average and exceeds the Bollinger Bands, it is safe to assume that the market is over-expanded (overbought). Conversely, if the price of certain assets drops significantly and repeatedly exceeds or touches the lower track, the market may be oversold or have reached a strong support level.
In addition, the expansion and contraction of the Bollinger Bands indicator may be useful when trying to predict the moment of price fluctuations. The wave band will move away from the middle rail line (expansion) as the asset price fluctuates violently, or move toward the middle rail line (contract) as the price fluctuations become weaker.
The Bollinger Bands indicator is more suitable for short-term trading, analyzing market volatility and predicting upcoming trends. Some traders believe that when the band expands excessively, the current market may be approaching the consolidation period or will soon reach a trend reversal. Similarly, when the wave band is too narrow, traders think that the market will undergo huge changes.
Each strategy has its drawbacks, Bollinger Bands has become one of the most useful and commonly used tools for focusing on very short-term prices in securities. Buying stocks when the stock price falls below the lower Bollinger Band usually helps traders to take advantage of oversold conditions and profit when the stock price returns to the central moving average.