What should we compare prices to when we wish to buy low and sell high? Bollinger bands presents tools that will help you answer that question with dependable statistical analysis–particularly if you use them in the right way. There is a quite unconventional but still profitable strategy of making use of Bollinger bands as buy signals. In this article, you will learn how you can use the outside of Bollinger bands to determine good purchasing opportunities.
Do you remember the fundamentals of Bollinger bands? The bands represent volatility measures that are located above and under a moving average. The standard deviation is used to calculate the volatility measures.. The Bollinger bands narrow as the volatility decreases and widen when the volatility soars. When the volatility rises or reduces, standard deviation changes with it. Owing to the dynamic nature of Bollinger bands, it is possible to use them on different securities with the default settings. In order to use the approach explained in this article, the default settings of Bollinger bands need to be changed.
Many charting packages can make the changes to Bollinger bands specified here, but if you don’t have one that can do so, or if you don’t know where to begin, try out freestockcharts.com. The charting examples discussed in this post use the very same website.
There are four steps that you have to do:
1. Use a moving average price for a proxy for the trend, back testing results reveal that a 44-period simple moving average works the best for this method. Having said that, it is not imperative to use a 44-period average, almost any moving average between 40-periods and 100-periods would be suitable here. You can get an idea of trading from the slope of this line, when it is sloping up, long and when it is sloping down, short.
2. As opposed to the default 20-day average for normal trading, you should utilize a 5-day average. It means that we will trade anywhere from one week to three months.
3. The default standard deviation is set to 2. You need to change it to 1.4, so that it covers 90% of normal prices in the past week. When making use of freestockcharts.com change the Bollinger band indicator that you have applied. You need to change two things; the standard period from 20 to 5 and the standard deviation from 2 to 1.4.
4. You should look for buy signals when the moving average is sloping upward while the price is under the Bollinger band.
Take a look at the following examples:
This example is of the chart Disney (DIS), which is shown from January to March. As you can see that there were ten days in January when the price dropped under the Bollinger bands.
When the price falls under the Bollinger band, it is an entry signal given that after this point the stock turns up and continues to rise. To duplicate these indicators, you can use any charting package, which will allow you to edit the Bollinger band indicator that you have applied. As said before, you can do this by using freestockcharts.com. You have to adjust two things; the default period from 20 to 5 and the standard deviation from 2 to 1.4.
It is clear from the chart above that whenever the price drops under the Bollinger band, it goes up in the next 5 trading days. Thus, you can easily identify and use this entry signal. Don’t forget, that the moving average line has to be sloping up in order for this entry signal to offer optimum usefulness.
On the chart, should you have purchased on anyone of those ten days where DIS drops below the lower Bollinger band, it wouldn’t have been difficult to have a profitable trade. As you can see that each trading signal had a minimum of one day in the next week when the price went up more than it decreased. Also, in the next two months Disney increased from the entry prices by approximately 12%.
Through testing it has also been shown that you can win this trade over 70% of the time if you do two things: allow a three to five percent stop loss setting and take profit every time the price rises more than two percent from the entry point. Furthermore, about 10 to 20 percent of the trades you come across will be occasions where you can let the trade run in your favor past the initial two percent target. Trading can be easy and profitable by making use of these signals from the Bollinger bands.
In the next example, we refer to the chart XHB (Homebuilders) for the months of February to May. As you can see that in the month of February, there are 9 entry signals; instances where the price falls under the Bollinger bands.
As you can see in this example, if you purchased this stock at one of the entry signals in February, XHB increased approximately 10% over the following month. In case you are working with this method, then it is extremely important to adhere to all the instructions to letter without overlooking any single detail. Notice in this example, around May 15 there is just this type of detail. The 44-period moving average had sloped downward.
If you stick to the rule in step number one then the possibility of entering into a trade after May 15 would be eliminated. This keeps you from losing money by stopping you from buying in a downward trend market. As soon as the moving average peaks and starts to turn over, exit your trades and do not get back into any, with this method, till the moving average line is again sloping up.
There are various ways to use Bollinger Bands. This approach works well if you want clear, easy to understand, entry signals. Again, you must ensure that you follow the four steps to the letter so that you don’t lose money. A 44-period simple moving average is ideally suited to be used in this technique. Nonetheless, any moving average between 40-periods and 100-period moving averages will work almost as well as a proxy for the trend. Even though this method for making use of Bollinger bands may be a bit uncommon, it helps you determine those prices that are, literally, outside the lines and good candidates for unusual profits.
A good way to make profitable trades is with the aid of Bollinger band trading. Regardless of whether you trade forex, stocks, or even options, if you know what the bands are saying then you can readily make lucrative trades. If you’re a trader then you should learn how to trade Bollinger bands.