Indicator of technical analysis, Bollinger Bands were invented by John Bollinger in the 1980s . His concept arose from trading ranges of measuring the instrument, to determine height or low price level in relation to other valuable assets.
The Bollinger Bands indicator consists of three elements:
- The middle line N- period is a simple moving average
- The upper line is a standard deviation above the middle line.
- The bottom line is standard deviation below the middle line.
Common values for N and K are 20 and 2, respectively. The choice of settings for the middle value is the simple moving average, but other averages can be used if necessary. Exponential moving averages, as a rule, are the second option. Traders generally use one and the same average value for the middle band and calculation of standard deviation.
Bollinger bands provide a relative definition of the top and bottom, in terms of price peaks – at the upper bound and the lower level – on the bottom band. The model of their picture, gives a clear understanding of the chart and it is well visible when comparing the price movement and the indicator for the systematic trading decision.
Interpretation Bollinger Bands
The use of Bollinger Bands varied among traders. Some traders are buying when the price touches the bottom line of Bollinger band and out of the market when the price touches the moving average in the center of the bands. Other traders buy when the price breaks up the upper line of Bollinger band or sell when the price falls below the bottom line of Bollinger band. Option traders often sell when Bollinger Bands are hhistorically far from each other or buy when Bollinger bands are historically close to each other, in both cases, waiting for the return of the price movement to the average historical level of volatility in the technical analysis of the market.
From recent researches was concluded that the trading strategy using Bollinger Bands can be effective on the Chinese market.
Percentage of data outside the Bollinger Bands will always be limited to a certain amount. Therefore, instead of trying to find about 95% of the data inside bands, as would be expected with the default settings, in the case of the normal distribution of the data, one can usually find less, much less, and such data are a function of volatility of the asset.
Stochastic Oscillator compares current closing price to its price range over a X-time period. Stochastic Oscillator is shown as two lines. The main line is called % K. The second line – % D, is a moving average of line % K. The % K line is usually displayed as a solid line, and the line % D is usually displayed as a dotted line.
There are three most popular method of using this indicator:
- Buy when the oscillator (either % K or % D) firstly falls below a specific level (for example 20) and then rises above that.
- Sell when the oscillator firstly rises above a specific level (for example 80) and then falls below that level.
- Buy when the line % K rises above the line % D
- Sell when the line % K falls below the line % D
Watch for divergences. For example: prices are making a series of new highs and the indicator fails to raise its previous high.
Technical indicator Momentum measures the change of the price of the financial instrument over a given period of time.
There are two main ways of using the Momentum indicator:
- Using the Momentum indicator as oscillator for trend-following. Buy, when the indicator has reached a bottom and turns up and sell, when the indicator reaches its peak and turns down.
- Using the Momentum indicator as a leading indicator. This method assumes that the market highs are identified by a rapid price increase (when everyone expects that the price will continue the path above), and that the market has reached a bottom, usually ends with the rapid price decline (when everyone wants to leave the market). The similar happens often, but it also can be wide generalization.
When the market reaches its peak, Momentum indicator rises sharply and then falls. Also, when the market is down, the indicator drops sharply and then turns up before the price starts to increase. In both of these cases divergences appear between the indicator and the price of the trading instrument.
The Envelopes indicator is formed by two moving averages, one is shifted upward and another one is shifted downward. The selection of optimum relative value of displacement of the boundaries of bands is determined with the market volatility: the higher it is, the stronger the shift is.
Envelopes indicator sets upper and lower limits of the price range. The signal to sell appears when the price reaches the upper margin of the band, a buy signal is generated when the price reaches the lower margin.
The basis of the Envelopes logic is that the activity of buying and selling pushes prices to extreme values.
The Accumulation/Distribution indicator is determined by the changes in price and volume. The volume acts as the coefficient of the weighting of the price changes. The higher the coefficient (of volume), the higher the price change (for this time period), which will affect the value of the indicator.
When the Accumulation/Distribution indicator (A/D) is increasing, it is the accumulation (buying) of the asset because the overwhelming proportion of the volume of transactions is related to the upward movement of the price. When the indicator falls, this it is the distribution (sale) of the asset because the overwhelming proportion of the volume of deals is related to the downward movement of prices.
The differences between Accumulation/Distribution indicators (A/D) and the price of the trading instrument are talking about the upcoming change of price. Typically, in the case of such differences, the price tendency is moving in the direction in which the indicator moves. If the indicator is rising, and the price of the instrument is falling, you should expect a reversal.