Bollinger Bands: Essential Indicator To Identify Overbought And Oversold Levels

In this second edition of the educational program, securities like AAPL, TSLA, SPX, SPY, IWM, QQQ, DAX and BTC will be analyzed showing an effective way to use technical indicators.

Bollinger Bands

They are a technical analysis tool developed by John Bollinger in the 1980s. They consist of a simple moving average line and two standard deviation lines plotted above and below the moving average. The purpose of Bollinger Bands is to provide a relative definition of high and low prices of a security. 

The following is a comprehensive guide on how to use Bollinger Bands effectively:

1. Understanding the Components:
- Simple Moving Average (SMA): The middle band is a simple moving average that is typically set at 20 periods.
- Upper Band: Calculated by adding two standard deviations to the SMA.
- Lower Band: Calculated by subtracting two standard deviations from the SMA.

2. Interpreting Bollinger Bands:
- Volatility Indicator: Bollinger Bands expand and contract based on market volatility. Wider bands indicate higher volatility, while narrower bands suggest lower volatility.
- Overbought and Oversold Conditions: When the price touches or exceeds the upper band, it may indicate an overbought condition. Conversely, when the price reaches or falls below the lower band, it may suggest an oversold condition.

3. Using Bollinger Bands for Trading:
- Bollinger Squeeze: A period of low volatility is often followed by high volatility. Traders can anticipate potential price breakouts when the bands narrow.
- Mean Reversion Strategy: Traders can use Bollinger Bands to identify potential reversals when the price touches the outer bands and returns to the middle band.
- Trend Confirmation: Confirming trends by observing the direction of the price relative to the moving average line and bands.

AAPL Example: