Bollinger Bands, developed by John Bollinger in 1980, was designed to confine the widely held price movements. It consists of a centerline and two price channels or bands below and above it. The central line denotes the exponential moving average, while the two price channels depict the standard deviation in the pattern of stocks under study. The price actions either expand or contract. The bands expand when the issue is volatile or expanding and during contraction, these get restricted in a tight trading pattern.
The Bollinger bands denote price targets. When narrow, the price jumps up or down within the two limits. It is believed that when the trading range is narrow its best not to trade, only otherwise a trader anticipates to make a small profit through a 1 or 5 minute chart.
Every type of investor, irrespective of what they are trading, uses Bollinger bands. From stocks to forex to bonds, it is used everywhere. Most traders use this tool to determine the oversold and overbought levels. This works best in range-bound markets, where the prices keep moving between the two bands.
The Bollinger bands help in measuring deviation and are very useful in diagnosing trends. Traders use two sets of bands, which are created using parameters of 1 and 2 standard deviation respectively, to look at prices in a new way.
The greatest advantage with Bollinger bands is the dynamic adaptation to the expanding and contracting prices, which are subject to volatility decrease or increase.
Bollinger bands are a useful tool for trend traders and faders. For trend traders, it is easy to evaluate the massive move in the markets while making use of these bands, which also helps in exploiting momentum. For faders on the other hand, Bollinger bands help in evaluating the trend weaknesses. Seeing the price fall, these traders can use the BB by bringing the next tag lower. Being extremely volatile, traders find this tool very useful. It even becomes easy to create the projection zone effectively. This increases the traders’ chances of not stopping on the market noise, while preventing his money, in case the trend bounces back.