The following chart example demonstrates the use of the
Bollinger bands with all the relevant interpretations.
These characteristics make this indicator a versatile one
and if interpreted properly it can give an accurate picture
of the price action.
But these following points should be
followed for an accurate interpretation.
- Price can, and does, walk up the upper Bollinger Band
and down the lower Bollinger Band.
- Tags (touch) of the bands are just that, tags not
signals. A tag of the upper Bollinger Band is not by
itself a sell signal. A tag of the lower Bollinger Band is
not by itself a buy signal.
Bollinger Bands Divergence Strategy
This indicator has certain characteristics, which make it
ideal for predicting a reversal of trend.
- Firstly, because of the way it is calculated, 85% of
the price action is contained within the bands and hence
it gives a very good indication of the price being
overbought or oversold, in that time frame
- Secondly, the widening of the bands shows increasing
volatility and the narrowing of the bands show decreasing
volatility.
- Bottoms and tops made outside the bands followed by
bottoms and tops made inside the bands call for reversals
in the trend.
- When price approaches the upper or lower bands, there
is almost always a reversal or a strong continuation. If
there is a reversal, we want to identify it correctly and
get in early.
The price of any currency, commodity, futures etc. across
all time frames display a unique characteristic that signals
a change in trend.
It is generally observed that price will make a last
thrust in the direction in the prevailing trend, before
changing direction.
This could be trend exhaustion or a final running of
stops in the market. This movement of the price is made with
reducing momentum, which is observed as a divergence between
the price action and any indicator.
The Bollinger bands show a distinct advantage over other
indicators/oscillators, as it shows when the trend change
takes effect.
We can potentially identify divergence when the market
has a close outside the band, followed by a close within the
band.
As mentioned above, this is a typical characteristic of
the Bollinger bands, which signals a reversal. But price
could move again in the direction of the prevailing trend,
thus making this move the final thrust in the previous
direction.
Though this is observed as a divergence, the other
indicators / oscillators do not tell us when price will
reverse. But the Bollinger bands do.
The next reversal which takes place inside the bands,
signal the change in direction.
This simply means that in case of a downtrend, the next
reversal of price in the upward direction will take place
above the lower band. The lower band thus acts as a support
for price, which signifies the change to uptrend.
This can be seen very clearly in this chart.
In other words, once the final thrust has
been made but finds support at the lower band, there is a
high probability that there will be a reversal.
