Bollinger Bands are envelopes that surround the price bars on a chart and are plotted with two standard deviations away from a smpe moving average. This is the primary difference between Bollinger Bands and envelopes. Envelopes are plotted a fixed percentage above and below a moving average.
Because standard deviation is a measure of volatility, the Bollinger Bands adjust themselves to the market conditions. They widen during volatile market periods and contract during less volatile periods. Bollinger Bands become moving standard deviation bands.
An important thing to keep in mind is that Bollinger Bands do not generate buy and sell sgnals alone. They should be used with another indicator.
For exampe some traders use Bollinger Bands with RSI. (Relative Strength Indicator) This is because when price touches one of the bands it could indicate one of two things.
It could indicate a continuation of the trend; or it could indicate a reaction the other way.
So Bollinger Bands used by themselves do not provide all of what technicians need to know-which is when to buy and sell. MACD can be substituted for RSI.
When combined with an indicator such as RSI, Bollinger bands become quite powerful. The RSI is an excellent indicator with respect to overbought and oversold conditions. Generally, when price touches the upper Bollinger Band, and RSI is below 70, we have an indication that the trend will continue. Conversely, when price touches the lower Bollinger Band, and RSI is above 30 we have an indication that the trend should continue.
If we run into a stuation where price touches the upper Bollinger Band and RSI is above 70 (possibly approaching 80) we have an indication that the trend may reverse itself and move downward. On the other hand, if price touches the lower Bollinger Band and RSI is below 30 (possibly approaching 20), we have an indication that the trend may reverse itself and move upward.
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