Today’s video is on a popular technical analysis tool, Bollinger Bands. Developed in the 1980s by John Bollinger, this oscillator is a technical indicator that incorporates the idea that volatility is dynamic, so the bands adapt as volatility increases and decreases. The tool uses a moving average with volatility bands placed above and below it. This provides the trader with a relative definition of high and low.
What Are Bollinger Bands?
Bollinger Bands can be used to identify W-Bottoms and M-Tops and help determine the strength of a trend. They can also help traders easily recognize highs and lows and can be used to find overbought and oversold areas. Since they are dynamic, they can be used on different securities with the standard settings.
Bollinger Bands are made up of a set of three bands that are plotted in relation to the security’s price action. The middle band is typically a simple moving average set at 20 periods. The outer bands are normally set two standard deviations above and below the middle band. If the price action becomes more volatile, the bands will widen. If volatility decreases, the bands will contract and move closer to the average.
W-Bottoms And M-Tops
Arthur Merrill, author of Behaviors of Prices on Wall Street, identified 16 classic chart patterns with a basic W shape and 16 classic chart patterns with a basic M shape. Bollinger Bands can be used to help spot these patterns. If the Bollinger Bands confirm a W-Bottom or M-Top, it could signify a potential breakout and possible trend reversal.
Overbought And Oversold
According to Bollinger, the bands should contain a majority of the price action, which means that a move outside of the bands should be considered significant. Generally, as the prices move closer to or break through the upper band, the market could be considered overbought and as the prices move down to or break through the lower band, the market could be considered oversold.
