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Trader Toolkit: Bollinger Bands

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Trader Toolkit: Bollinger Bands

With more and more trading platforms and the growing allure of low-to-no-fee brokerages, new traders are confronted with a deluge of options when it comes to trading and investing. But lost in the promises of sleek interfaces and free shares for signing up is the fact that successful trading takes time, practice and an understanding of resources experienced traders use on a daily basis.

With that in mind, we’re going to use this new series of articles to take a look at the charts, ratios and indicators that play an integral role in how traders generate ideas and form convictions on their medium- or short-term trades. To do that, we’ll be using the charts and tools available on the Webull trading app, which offers traders access to real, zero-commission trading in addition to a suite of advanced trading analysis and charting.

Invented by financial analyst John Bollinger in the early 1980s, Bollinger Bands have managed to gain widespread use across the equity market thanks largely to the indicator’s versatility and broad applicability as a price indicator.

Much of Bollinger Bands’ appeal lies in the fact that the data points that make up the indicator constitute a relative range into which a stock’s current price falls. Traders can glean a lot of information about a stock’s current value depending on how its price aligns with the upper, middle and lower ranges of the Bollinger Bands. Traders can also get an indication of the stock’s recent behavior based on how wide the gulf between ranges is.

As typically formulated, the three lines that constitute the Bollinger Bands are derived from a stock’s simple moving average—the middle line—usually 20 closing periods. The outer bands use that SMA figure as well, but add or subtract some multiple of the stock’s standard deviation over that period, usually double. This all comes together to form a visual approximation of the range in which a stock could reasonably be expected to move within the near future, like in the three-month chart for Apple Inc. (NASDAQ: AAPL) below.

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Image source: Webull

Another benefit to Bollinger Bands is that traders can extract a lot of information on a stock’s behavior from a glance. In the chart above, it’s clear that Apple has tended to trade on the higher-end of its recent average, suggesting a good proportion of buyers keeping the stock buoyant. On the other hand, the upper and lower bands are widening, suggesting an uptick in price volatility that could forecast incoming headwinds for Apple’s price.

Because of variables that slot into the Bollinger Band equation, Bollinger bands can also be customized to a certain degree to reflect a traders particular strategy and time horizon. 

For example, traders can exaggerate or smooth the chart lines by either increasing or decreasing the period length from which they draw the SMA. They can also increase or decrease the multiple being used on the standard deviation when calculating the upper and lower bands, which will exaggerate or mute price swings. 

Take a look at the 1-year chart for Applebelow, which takes the 100-day SMA and uses a 2.5 multiple on the standard deviation. These variables are useful for those looking to examine a stock under a different time frame.

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Image source: Webull

Although traders can interpret Bollinger Bands from an array of angles and in a variety of ways, it’s important to remember that the information that makes up which Bollinger Bands are both price-dependent and relative to a stock’s recent historical performance. While that means Bollinger Bands can paint an extremely detailed picture of a particular stock’s relative value, it doesn’t take into account the overall quality of a stock relative to its peers or how the volume and trading activity in the stock might be affecting performance.

However, used in conjunction with other research and technical signals, Bollinger Bands can provide that extra ounce of conviction to enter in to or close out a trade.

Webull is a content partner of Benzinga

Posted-In: Bollinger Bands WebullFintech Education General

 

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