Futures Trading 101: What Do Bollinger Bands Tell Me?
If you placed a rubber band around several pencils, that elastic would contract around the pencils and bend and stretch to conform to the shape of the pencils. It stretches just enough to surround the perimeter of the pencils. If you could only see the elastic and not the pencils themselves, you’d still have a pretty good idea of the shape that the group of pencils made.
There is a similar concept in trading. Until the 1980’s, people thought that volatility was static. Things moved up and down and traders observed those rises and falls in trading within a narrowly defined context. John Bollinger, however, realized differently. He realized that volatility was a dynamic fluctuation and saw that volatility could be interpreted within a larger context.
Introducing Bollinger Bands
He created a concept called Bollinger Bands, which are three bands that track with pricing in order to indicate opportunities measured by price and volatility. The middle band is a simple moving average. The upper and lower bands show the simple moving average adjusted by the standard deviation of the simple moving average.
In this way, traders can see the relative volatility of an investment. Bands that are wide apart indicate highly volatile trading. Bands that are close together indicate relatively quiet trading. It’s very much like the elastic band that stretched and contracted to take the shape of the group of pencils, above.
What does it matter to you?
So, how can you use Bollinger Bands when you’re trading? Bollinger Bands help to show price against volatility, so some traders might use them to know when to buy low and when to sell high, based on whether the price is breaking through one of the specific bands.
Bollinger Bands is a popular trading indicator and some experienced investors swear by it. Some use it as a primary trading indicator to alert them to possible buying or selling situations while others prefer to use other indicators and follow it up with Bollinger Bands as a confirmation tool.
If you’re an avid trader and you’ve never used Bollinger Bands before, add them to your trading arsenal cautiously. Watch them but continue to make decisions as you normally have and see how they compare. If you’re looking around for a trading platform, make sure that it has Bollinger Bands as part of its charts and indicators. Even if you dont use it often, it’s a powerful tool you don’t want to be without!