BOLLINGER BAND SQUEEZEBollinger Bands
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We all are familiar with the much popular Bollinger bands (BB). It has two bands - Upper BB and Lower BB. These bands envelope the price of an instrument and are plotted at a standard deviation level above and below a simple moving average (sma) of the price (20 sma in most cases). BBs help in determining whether the price is high or low on a relative basis.
The Squeeze
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One of the most effective way to utilize BB in a trending environment is to trade the squeeze.
In order to understand squeeze you must know what is volatility.
Volatility is simply the rate at which the price of an instrument increases or decreases over a particular period.
In other words, If the price of an instrument is fluctuating up and down very fast in a short interval of time, hitting highs and lows, it is said to be highly volatile. On the other hand, If the price is moving up or down more slowly, or is relatively stable, it is said to have low volatility.
BB works on the basis of volatility. When the volatility is higher, the BB expands and when the volatility drops to historically lower levels, the BB squeezes. John Bollinger used an indicator known as 'Band width' to measure volatility.
According to John when Band width drops to its six month lows, it leads to squeeze.
Squeeze is seen when price trades in a narrow range, or consolidates as we call it very often. Under such conditions, the UB and LB come closer to each other or pinch together. It often reminds me of watering plants with a garden pipe. We pinch the pipe so as to control the flow and increase the range of sprinkles. Same is true for BB. The pinch or squeeze (low volatility environment) leads to expansion (high volatility environment). So low volatility leads to high volatility and vice versa.
Points to be noticed before trading squeeze:
First, the price must gyrate in a narrow range for some time;
Secondly, the Band Width should drop to its six month low value;
Thirdly, expansion in the direction of the primary trend will bring the odds in your favor. Following primary trend will also help avoiding fake moves against the trend.
Above Nifty chart is a good example of squeeze on the daily timeframe. The band width value reduce to 0.02 in July 2021 from 0.09 in 2021 June. Also observe the price movement and a small fake out against the primary trend at the end of July. Finally Nifty expanded in the primary direction.
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