Technical Analysis
Using Bollinger
Bands
There are three lines
used for the Bollinger Band indicator: the upper, lower, and
the simple moving average that is between the two (sometimes this third line is not used). The upper/lower
bands are plotted two standard deviations away from a simple
moving average. Standard deviation is a measure of volatility,
therefore Bollinger Bands adjust themselves to the market
conditions. When the markets become more volatile, the bands
widen and they contract during less volatile periods.
The closer the prices move to the upper band, the more overbought
the stock is. The closer the prices move to the lower band,
the more oversold the stock is. Below is an example using
General Electric (GE). Bollinger bands are blue for the lower,
green for the average, and red for the upper band:
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| This chart
was supplied by Barchart.com |
We have circled three key points on this chart. The blue circle
is where the stock price started to create a "base" on the lower
band, it appeared that the stock was oversold. Buying at this
point would have been a wise choice, as the stock proceeded
to jump 20% or more in the next few weeks.
The two red circles are areas where the stock price was touching
or breaking through the upper red band. This is usually an indication
that the stock is overbought. In both instances, the stock
dropped substantially in following weeks.
Bollinger Bands are a good tool to use, but as we've mentioned before, never invest solely based on what just
one indicator says. Notice there were instances when the stock
touched the upper or lower band and did not react. Rather than
basing their investment decisions on Bollinger Bands, many investors
use this indicator mainly to solidify a decision they are about
to make.
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