Confused When Market is Oversold or Overbought? Try Bollinger Bands


Read this article to learn more about Bollinger Bands, the method used by traders to determine the trend changes that could affect their business. Getting to know whether a market is overbought or oversold is easy with this approach.

Determining the trend change is not an event. One of the biggest challenges that traders face is to predict the start of a new trend. Besides, getting to know whether a market is overbought or oversold could also be a hectic process.

Thanks to the Bollinger Bands! Things have now been made easier by the technical analysts. Almost every trader uses this technique. One can't ignore its benefits which includes measurement of market volatility. With this, a trader can identify oversold levels; the gauge is an ongoing market trend and figures out trend reversals-according to Mazhar Mohammad who is a chief market strategist.



Predicting a Change in Trend


According to Victor Sperandeo-an U.S excellent financial commentator, you need three steps to identify a change in trend. With these steps, you are assured of getting a trading opportunity and avoiding the loss of trades. They include:

  • A broken trendline

  • Presence of retest and failure

  • Prices falling below the prior low
  • Understanding Bollinger Bands and When to Use It


    With the few benefits we have recapped about Bollinger bands, we can agree that they are indeed an excellent market vitality indicator. The question is, how do I apply them to trading and what are the strategies that will produce an opportunity to win?

    These influential bands summarize the movement of a stock price. It does this by providing the applicable limits of highs and lows. Based on the viewing time frame, you can get the moving average which then determines the intermediate trend. Click here to see the diagram.

    To plot Bollinger Bands, you require two standard deviations by drawing the upper and lower lines to get the simple moving average. Normally, the average is 20.

    You may be asking the reason behind the standard deviation; this gives the traders an idea concerning the market direction since it measures the volatility and the band's adjustments regarding the market conditions.

    The below calculations can make it easier to understand.
    Standard deviation denoted as s'
    Middle band denoted as MD
    Lower band denoted as LB
    Upper Band denoted as UB
    MD=20-period moving average
    UB= 2 s' + MD
    LB= 2 s'-MD

    The below diagram will help in understanding the lower and upper band. Click here to see the diagram.

    If the market is volatile, the upper and lower band widens, and vice versa.

    To apply Bollinger Bands, traders should keenly observe the expansion and contraction of the upper and lower bands. According to Birendrakumar Singh, commissioner of customs and excise department, prices are likely to open either downward or upward.

    At the time of price reversal, the upper and lower band expands in the opposite direction- either downward or upward. Similarly, when the price reversal thrust, both bands rapidly rise towards the course of the price trend.

    Interpreting Bollinger Bands


    To clearly understand how Bollinger Bands works, here are some points that one needs to consider:

  • If the bands contract, there are chances that sharp prices will be present as volatility will drop.

  • If the price line goes beyond the band range, that is an indication that there will be a current trend continuation.

  • If new highs and lows are detected outside the bands, tagged along by highs and lows inside the bands, this is an indication that there will be a future trend reversal.


  • The use of Bollinger Bands tends to vary with different dealers. Some can buy when the prices tend to near the lower bands; others may leave when the price line is on the middle line.



    How Not To Panic When Faced With Market Crashes


    What should a trader do when faced with big market crashes? Is there a way you can do to know the current state of a market? The answer is a resonant yes. Bollinger bands are instrumental when it comes to such situations.

    Let's take an example if the recent situation of Nifty's downtrend of the year 2015-2016. According to Ranvir Singh of Systematix Shares, the use of 3 standard deviations and a 120-day moving average was used to identify the downward trend reversal. Click here for more information.

    The Bottom Line


    Bollinger Bands can multi-task. The reason is you can combine them with various indicators easily because they are composed of different things-standard deviation and moving average. Thus to find winning trades, traders should merge Bollinger Bands with indicators such as Stochastic and RSI.


    Article by Tony John
    Tony John is a professional blogger from India, who started his first Weblog in 1998 at Tripod.com. Tony switched to blogging as a passion blended business in the year 2000 and currently operates several popular web properties including IndiaStudyChannel.com, Techulator.com, dotnetspider.com and many more.

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    Comments

    Author: Umesh21 Mar 2019 Member Level: Diamond   Points : 5

    Highly technical this Bollinger Band seems to be but can be used to one's satisfaction as the powerful software make it be understood by the traders in simple ways.

    Today, due to phenomenal advances in computer sciences and computational software, the traders have got access to the latest tools to predict the market trend. I believe that in normal conditions these indicators must be giving good support to the traders for taking judicious and gainful decisions for gains in the market. At the same time, the market is prone to various risks like poetical situations, fraudulent practices by some traders and things like that. A shrewd investor will discount all those things in his calculations and speculations.

    I will like to illustrate one example here that how the market sometimes behaves in fearful ways and wipes out the gains in quick succession to that dreadful event.

    In the 1990s I was working in a company in Chennai and some of my colleagues were good in share market speculations and used to give advice to us in that respect. During that time some companies came into being dealing in an alternative source of energy like solar and wind energy. As these companies were seen doing a good prospective business their share prices rose significantly. What we could not notice was that not only these new prospective companies but the shares of all other companies were also on the rise. The gullible investors like us jumped in the queue to make quick money but the destiny had something else reserved for us as a few months later (during 1992) we came to know that there was a big fraud in the market and one broker Harshad Mehta was instrumental for fictitiously raising the share prices in the market.

    The bad thing was that the market collapsed and remained subdued for a long time and people suffered huge losses. The worse thing was that the share prices of wind energy companies nosedived and some of them were closed. These shares are still at their low ebbs even after 25 years. So we lost heavily but learned the lesson that share market is not a place which works with the principles of mathematics but yes these tools can be used to make better investment decisions in normal circumstances.



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