Bollinger Bands Strategy
Definition
The Bollinger Bands strategy is often used with the assistance of other indicators to make conceptual and strategic trading decisions. Bollinger Bands consist of three bands total: an upper band, middle band, and lower band. These separate bands are each used to highlight extreme prices in a specific security. The upper band is associated with overbought securities, whereas the lower band points to securities that are oversold, and the middle band acts as a moving average.
It is common after a lower band has been broken by heavy selling for the price of the stock to revert back above the point of the lower band and move closer to the middle band. The Bollinger Bands strategy specifically profits from this type of occurrence - where the strategy demands for a close below the lower band. Therefore, it can be determined that buying the breaks of the lower Bollinger Band is a specific way that traders and analysts are able to take advantage of oversold conditions.
History
Bollinger Bands were created in the 1980s by John Bollinger. This strategy has become one of the most frequently used tools by technical analysts since its inception towards the end of the 20th century.
Takeaways and what to look for
The Bollinger Bands strategy is commonly used to point out oversold market conditions. However, instances may occur when the strategy is correct, yet selling pressure continues. During these instances, it can be hard to determine when the selling pressure will end and therefore, a protection of sorts is needed for once there has been an acute decision to buy.
Stop-loss orders are one of the many strategies that were developed in order to protect traders and analysts from trades that continue to ride the band lower than necessary.
Limitations
There are quite a few limitations to this strategy, but they often depend on the specific case and how the strategy is being used to track market trends. Price is a factor that does not often rebound quickly with the Bollinger Bands strategy. Although the strategy can often correct itself, this doesn’t always stop traders and analysts from experiencing significant losses due to rebound delay.
Additionally, as mentioned above, it can be hard to determine when selling pressure will end and so it is essential for the strategy to be paired with a protection that will ensure stability when a trader has decided to go ahead with a buy.
Summary
The Bollinger Bands strategy is often used with the assistance of other indicators to make strategic trading decisions based on the status of the market and position of stocks. When there is consistent seller pressure present, and this pressure is not corrected in a timely manner, stocks then continue to make new lows into oversold conditions. In order to use the Bollinger Bands strategy effectively, it is advised that you have a decent exit strategy, such as stop-loss orders. This is to ensure that you and your trade are protected from a stock that continues to ride the lower band, without knowing at what point selling pressure will end.