Bollinger Bands
A Bollinger Band is constructed by placing upper and lower bands around a moving average – the band width is not constant but instead proportional to the mean square divergence from the moving average over the specified period of time. Based on the Bollinger Band analysis, the decision to enter/exit the market is made when the price rises above upper Bollinger Band resistance or falls below lower Bollinger Band support.
If the price breaks through upper and lower bands and then comes back inside then it is considered a good time to enter the market. If it breaks through the upper band and then comes back just below the upper band, it is time to sell. If it breaks through the lower band and then comes back just above the lower band, it is time to buy. However if the price breaks through the upper or lower band and then comes back right away it may be a false signal.
Bollinger Bands measure volatility:
- When the market is more volatile and volume is high the bands widen. It indicates that the prevailing trend is strong and likely to continue or a new trend has just started.
- During periods of low volatility bands are narrow. It is a period of consolidation to continue the prevailing trend or just before the reversal of the trend.
In a bullish market, moving average is the support level, whereas in a bearish market it is the resistance level.
