The pricing of shares on a stock market and their volatility could be quite unpredictable and sometimes quite illogical. It becomes difficult to even make short-term predictions on the indices and what direction they could take and the factors that may influence stock price variations. If this is the case with individual stocks imagine the chaos that ensues across a section of stocks. Thankfully, there are technical analysis tools developed by analysts that help narrow down stock market behavior to a certain pattern thereby lessening guess-work and reducing large scale losses that may result from a bad call on the market.
One such technical analysis tool is the Bollinger band, invented sometime in the 1980s by Mr. John Bollinger, a Chartered Market Technician and a Chartered Financial Analyst.
Here's an explanation of these Bollinger bands and how to trade using Bollinger bands like a professional.
Bollinger bands are devised to indicate a relatively accurate definition of high and low of a stock price. By the bands' definition, stock price is high at the upper band and low at the lower band. Over a course of time, this definition is helpful in vigorous identification and recognition of a pattern that further aids in comparison of pricing action with actions of indicators thereby enabling trading decisions systematically.
Bollinger bands consist of three bands also known as the upper, center (or middle) and the lower band. The middle band indicates a simple moving average and is set at twenty points, while the upper and lower bands indicate the chart points which are two standard deviations away from the moving average indicated by the middle band. The variances mapped by these three bands give stock traders a good feel what the trading price of a particular stock is on the market as compared to prices of the said stock in the recent past. A basic premise of the Bollinger bands is that the price should normally fall between two standard deviations that are indicated by the upper and lower bands.
The primary purpose for which traders use the Bollinger bands is to identify if a particular stock has suffered a potential case of over-buying or over-selling. These sorts of indications are very crucial and assist in taking calls on buy or sell within rather accurate range of the happenings on the market. The upper and lower bands also indicate selling and buying times with prices staying outside the upper or lower band indicating a strong trend for the stock which also means that it is not the time to trade any reversals for the stock. Naturally, one would sell at the upper band and buy at the lower band. A clairvoyant trader would then merge this data with his other findings to successfully advise clients on playing the stock market.
The Bollinger bands are trade analytical and technical tools - in other words, a mechanism to study and map movement and behavior of stock prices on the stock exchange. This only means that a one-time reading of the Bollinger band cannot be relied upon for taking trading decisions. Rely on other indicators for arriving at the final decision. Observe a Bollinger band for a period of time where stocks could show a burst after relative low volume activity. Make optimal use of this technique to reduce the gambling element in stock trading.