Bollinger bands are one of the most commonly used indicators based on volatility. There are two bands, Upper and Lower bands which are placed above and below the moving average respectively. Normal moving average used with Bollinger band is 20 SMA. The way how Bollinger band differs from other indicators is that the bands widen when the volatility is more and narrow when the volatility is less. The volatility is based on Standard Deviation.
In the chart shown, Bollinger bands can be seen with upper, lower and middle bands. The middle band is a simple moving average
Effective Strategies used with Bollinger bands
W-Bottoms can be used with Bollinger bands to identify the upcoming bull phase after a bear market bottom. Four points to remember for the confirmation of W-Pattern: In the first step, the fall starts and makes up a contact with the lower band. It may or may not cut the lower band.
Second step, the candles travel towards the middle band to form an intermediate rally. Third and most important step, the fall continuous but this time cutting the previous low. It’s important to notice the second bear and new low phase ends above the lower band without cutting the lower band which indicates that the stock is less weak. Fourth and final step, wait till the previous high for confirmation of bull phase and buy after the breakout.
M-Tops are exactly reverse to W-Bottoms. It helps in finding the upcoming bear phase after a bull market. Let’s put it in the other way, it helps in finding the M-Bottom (M Pattern bottom) which confirms a bear market. Once again, four points to analyze while predicting the M-Top – Forming first high, intermediate fall towards the middle band, making new high (importantly not cutting the upper band), breaking the previous low.