What are Bollinger Bands?
Bollinger Bands is a tool that combines a Moving Average and a standard deviation. This indicator is a technical analysis tool that has many effects and is very valuable for investors. There are 3 basic components in the Bollinger Bands indicator:
- Moving Average: default use of 20 sessions; SMA (20)
- Upper Band (Upper Band): the upper band usually has a standard deviation of 2, calculated from 20 session price data. Has a position above the moving average (20).
- Lower Band: the lower band usually has a standard deviation of 2 and is below the moving average (20)
There are 3 main methods to use Bollinger Bands:
– Range of bands.
– Break through the level of Bollinger Bands.
– Options trading strategy (Option).
Bollinger Bands operating range
Between the upper and lower bands of Bollinger Bands is the active range of most of the price line. Very rarely, the price line moves out of the Bollinger Bands, the price line tends to revolve around the moving average (20) SMA.
Investors buy or buy widely when the price line falls below the lower band of Bollinger bands.
Investors sell or start to stop buying when the price line is outside the upper Bollinger Bands.
Areas of caution:
- If following the initiative, investors should buy or sell when the price line touches the bands of Bollinger Bands. Investors should also wait and see when the price line moves outside above or below the Bollinger Bands and then the price closes back inside the Bollinger Bands, this is an opportunity to buy or sell short. The above trading method is a way to reduce losses when the price line breaks out of the Bollinger Bands for a short period of time. However, this also misses many profitable opportunities.
- Another extreme different from the above method is the use of the breakout of the Bollinger Bands.
Breaking the level of Bollinger Bands
This is basically the opposite method and has more advantages than the Bollinger Bands range method. The necessary condition before surpassing the threshold is that there must be many sessions of consolidation of the threshold price. If the price closes outside the Bollinger Bands, then we have to use other indicators and at the same time use the support or resistance line to make the appropriate decision.
The price line must be above the upper band of Bollinger Bands and there have been many previous consolidation sessions at this price level. Other indicators confirm the same.
The price line is below the lower band of Bollinger Bands and other indicators also imply this.
In addition, Bollinger Bands can also be used to measure the direction of price trends:
– The price trend is strong when the price line tends to always be in the upper half of Bollinger Bands, that is, the range between the upper band and the moving average (20) SMA. At that time, SMA(20) is the dynamic support line for the price trend.
– On the contrary, a strong downtrend occurs when the price line is lower than the lower half of Bollinger Bands; is limited by the moving average SMA(20) and the lower band of Bollinger Bands. At this time, SMA(20) will be the dynamic resistance line for the price trend.
Using Bollinger Bands is very suitable for the school based on price fluctuations for trading. Therefore, it is very useful for option traders.
Options trading strategy
There are two basic ways to trade options based on price fluctuations:
1. Choose to buy options when the price fluctuations are small, in the hope that the price fluctuations will increase to sell the option at a higher price.
2. Choose to sell the option when the price swings are high, in the hope that the price swings will decrease and then buy the option back at a cheaper price.
Bollinger Bands will give option investors more solid business ideas when the option is relatively expensive (high volatility) or relatively cheap option (low volatility).
When options are relatively cheap, Bollinger Bands shrink significantly, buy options such as a 2-way stock contract (straddle) or a 1-way stock contract (strangle).
+ Argument: after a sudden rapid move, the price line tends to consolidate confidence in a certain price range (trading range). After the price line stabilizes; For example, Bollinger Bands have roughly the same values for several sessions. Then usually the price line will start moving again. So buy option when Bollinger Bands tighten, this is a smart strategy.
When the option is relatively expensive, then the Bollinger Bands expand significantly, investors should sell the straddle or stragle option.
+ Argument: after the price line rises or falls significantly, the components of the Bollinger Bands are separated too far from each other in many trading sessions. After that, the price line tends to return to a consolidating state and will become less volatile. For that reason, when the components of Bollinger Bands are far apart, the price line is likely to tighten in the future.
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