In this article, we will look at the Stocks Market and how we can use the Bollinger Band Indicator to effectively trade. Unlike the Forex Market I usually discussed about on my other Forex Strategies Category, the Stock Markets can be a little bit tricky if not traded with caution and with the right knowledge. If you ready to use this strategy, then I suggest you take this article serious and follow all I am going to be talking about below.
It is a good practice if we first understand how this Indicator works and that is what we be doing for the first few minutes so I suggest you read to be properly equip.
What are Bollinger Band Indicator?
The Bollinger Band is a technical Indicator that was created by John Bollinger. This Indicator is made of up 3 lines which are shown around the price of stocks and when you have it attached to an active chart it, this forms a channel that candle sticks move through.
These 3 lines of the Bollinger Band are the upper, middle and lower. The upper and lower lines are the volatility bands while the middle line is a moving average. The volatility bands widen when the general volatility of the stocks increases and narrows when the volatility decreases.
Remember that the Indicator values needs to be set by the user and there is no magic settings. So you have to use your own setting or stick to the default setting that came with the Indicator.
NOTE: for the examples on this article we will use the default setting.
How to Attach the Indicator to a Chart?
Attaching the Bollinger Band Indicator to a trading chart is pretty easy, if you are the using Meta Trader 4 or 5 you can simply attached it by going to the INSERT tab of the dash board then click INDICATOR, then TREND and then choose BOLLINGER BAND, the picture below can help.
How Are the Bollinger Band Calculated?
We cannot finish the discussion on Bollinger Band without looking on how they are calculated. Remember I said earlier that the Bollinger Band are made up of 3 lines (upper, middle and lower) let us look at how they are each calculated.
The Middle Band is just the representation of a 20-day simple moving average (SMA), though that depends on the setting you use
The Upper Band is a combination of the 20-day SMA + (20-day standard deviation of price x 2)
The Lower Band is a combination of the 20-day SMA – (20-day standard deviation of price x 2)
Practical Example of Using the Bollinger Band
We have look at the theoretical aspect of using Bollinger Band, let’s now see how these can be use on stocks and be profitable.
Understand that the primary aim of using the Bollinger Band is to look for areas of DEMAND and SUPPLY, now let’s get down to the basics.
The time frame I used on this chart is the daily time frame.
The indicator’s setting are the default, that is, a period of 20 simple moving average (SMA), deviation of 2.000, price calculation applied to the closing price.
Our first example will be on AT&T INC.
If we look at the picture above, you will notice some areas, which I circled with red and the other with black. The red circle are the demand and supply levels that properly follows the rule of the indicator, while the black areas are areas with false signals.
Remember we are using the Bollinger Band to find areas of demands and supply, the first circle showed that there was an excessive supply for the AT&T INC. which later lost its upward momentum and fell, causing a demand for the later again.
In the Financial Market especially in Stocks, Forex and Commodity Market, the price do not move in a straight line but rather in a zig zag pattern and that’s why to spot demand and supply levels most time are difficult.
Using the upper band and lower band we can easily spot these (supply and demand).
Let’s look at the next example;
Devon Energy Corporation
The DVE stocks shows some key areas that I would love to show to you guys, if you properly examine the pictures, you would notice that the black spots on the charts are areas that gave a false signal. So how do we manage to avoid such?
The truth is losses are totally inevitable but can be reduced to the minimal level and I will show you how, at the conclusion apart of this article.
The next example will be on
Delta Air Line INC.
This stock have numerous gaps which is a bit good if you are able to spot these areas of demand and supply before placing your trade.
Consider this article as an eye opener to show you the power of using the Bollinger Band, in my later articles I will show you various techniques and strategies which can be used alongside the Bollinger Band Indicator.
using the Bollinger Band to trade stocks is not a “fail proof” strategy or the “holy grail” as such it is prone to false signal which cannot be totally eliminated but can be reduced or contain, let me give an example.
When trading, there tend to be some traces of emotions attached to each trade such as “when should I long or short“, “should I close my open position now or later” questions like this tends to influences our action which can either increase our loss or profit.
These can be reduced, by using pending order example if you think that stock is reaching a supply level using the details from the Bollinger band you can set a pending order at a level above your intended level, this helps to make sure you do not enter a trade too early and to be able to catch a better price.
Using a good risk management is very important, for example if you are you enter a trade on the DAL stock you can use a risk ratio of 1:3 that means if you enter into a long trade at $50, your Stop can be at $40 while your profit can be at $80, for every trade you win you will be able to offset 3 of your loss which is a good trading method.
Keep in mind that stocks are not as volatile as forex and moves in a much slower pace that is why it is recommend to trade stocks as a long term investment plan
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