Newbies in trading find it hard to decipher the usage of the technical indicators. When you reach the trading platform and you get to see these red and green bar charts with lines fluctuating, would you easily grasp the idea behind these? For some it could be yes, but for the first time traders-No.
Probably others wouldn’t agree, but in most cases traders tend to look for the last movement of the stock, if the chart shows its green, then it’s going up; if they see a red candle, then it’s going down. However, that’s not purely accurate. Technical indicators are not used that way. It isn’t about those lines in different colors and the dots moving up and down only.
The commonly used technical indicators include, Moving Average, Parabolic Sar, Fibonacci, Stand Deviation and Bollinger Bands. Among these indicators, one of the easiest to comprehend is the Bollinger Bands.
The Bollinger Bands comprises of two bands, the upper and the lower, and a center line. (See Figure 1.1.) These two bands expand and contract as the trading session occur. At times the band contract it means that there’s a tight pattern; tight trading typically leads to breakouts that often win. On the other hand, if the band expands it only means that the stock or the equity is volatile. A volatile market means that there’s Unpredictable and vigorous changes in price within the stock market.
For instance, in the chart below, Alibaba remained in a tight trading range in the whole month of June and even extended in the following month. When it got too tight in the first week of August, a high volatility was expected. Apparently, the price jumped from 87.41 to 96.20. This price hike was supported by the upbeat earnings report of the e-commerce company. That’s one important notion of using the Bollinger band, after a low volatility comes a high volatility.
If the price touches the upper band, it doesn’t necessarily mean that it’s a buy or sell signal, the same with the case of the lower band. Trading takes patience, you need to wait for a few bars, especially if you are on an hourly timescale.
- · Price Volatility is basically based on the outer Bollinger bands, thus the expansion will lead to price fluctuation.
- · Typically, the Bollinger Band is set to 20-period moving average. When the price surpasses the moving average it means the trading direction has changed. There are instances the moving average can be used as a trading exit signal.
- · A reversal signal may happen as the price goes beyond the outer band then rejected instantly. In general, reversal means there’s a series of price hike and it will be followed by a successive downtrend.
- · When the price goes beyond the upper barrier, the prices are thought to be overbought or oversold. Stocks that are oversold is bound to have a significant recovery commonly known as a price bounce. This mostly happens when there’s market panic selling. On the other hand, if the stock is overbought then it has surpassed the expected rally- this makes the price vulnerable to reversal.
- · At times that the price is close to the outer band, it is an indication of a strong trend for the stock. If the price is away from the outer band, it only means that the momentum will fade in the coming session. Further, the price that goes into the outer band signals a lack of power.
Bollinger Bands is pretty easy to use compared to other indicators simply because the movement is right in front of your naked eyes. This indicator shows the massive and the palpable price movement of the stock without grinding too much the technical side. In my point of view, traders need to be attentive in the price movement and the relative news of a specific stock. This strategy could lead to a better understanding of the price movement and could provide a more accurate forecast.