How to use Bollinger Bands to Detect Market Moves

Standard Deviation vs. Bollinger Bands

Standard deviations represent a classical statistical measure of volatility. For the investment markets, at any particular moment, the standard deviation reflects upon the variation in price that can occur relative to the fair underlying market value.

In essence, one would suspect that trading would always occur within this range, as the fundamental aspect of price changes are a result of the relative supply and demand available in the market.

Bollinger bands, when they expand, demonstrate increased volatility and interest in a particular trading instrument.

Contraction of the bands reflects upon uncertainty and a lack of interest in the market.

Reviewing graphical representations of Bollinger bands, one can see that price movements almost always occur within the limits representing the calculations derived.

Using Bollinger Bands for Entry and Exit Signals

For the individual investor attempting to determine optimal points of entry and exit, penetration of the bands represented by Bollinger limits provide opportunities to detect signals for significant market moves.

As investments tend to trade for long periods of time within a certain amount of detectable volatility, when that volatility has been penetrated, as exemplified by breaking one of the upper or lower bands, this becomes a prime signal that a significant market move is about to occur.

The purpose of the calculation of these limits is to filter out insignificant price action. Short-term price movements are rightfully viewed as random by nature.

Any individual can view the erratic character of short-term price variations. John Bollinger, using classical statistical methodologies and techniques, introduced a tool for the individual investor to eliminate the static noise that occurs in trading activity.

As the band's measure volatility, whenever they approach an upper limit, the investment is viewed as being overbought.

Conversely, when they approach the lower limit, the investment under consideration is viewed as being oversold.

Through the graphic representation presented, one can see that the overwhelming majority of the time, prices will trade between the Bollinger limits identified.

Effective Bollinger Band Techniques

As such, one technique for the detection of successful market moves is to sell at the upper limit and buy at the lower limit.

Historically, such a strategy produces consistent results. These results, however, do not always occur.

Consequently, one should always attempt to use other indicators to verify suspected movements. When confirmation can be ascertained, trading results are greatly improved.

It is not only possible to determine movements by the approach of limits, but also profitable entries and exits.

Penetrations of these Bollinger bands are equally attractive as entry and exit points for position undertakings.

These penetrations represent volatility signals that the trend will continue in the direction of the penetration.

No one indicator is infallible. Bollinger bands represent an attractive tool to determine market movements. They should be used, however, with other indicators to improve their performance results.