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TradingDay.com > Technical Analysis Tutorial

T e c h n i c a l   A n a l y s i s   T u t o r i a l
by Alan Farley

Bollinger Band Tactics

Bollinger Bands draw their power through two important characteristics. First, they exhibit an underlying trend-range axis just like price or moving averages. Second, they constrict or expand as they move. The interaction between these two forces draws unique patterns as bars unwind through its boundaries. Candlesticks work especially well with bands. For example, a Doji that strikes through a constricting band effectively signals a short-term reversal.

BBs bend and twist in response to price movement. These undulations predict how far trends should stretch before central tendency forces them back toward a central axis. Complex relationships develop between price-band direction and price-band constriction. For example, a trend tends to pause when constricting bands oppose it. It takes great skill to predict the bands' ultimate impact on price but is well worth the effort. More than any other tool, BBs pinpoint hidden swings and telegraph whether the profit door lies open or closed.

Bands may swing through relative highs or lows and then pull back into proportional retracement to start another trend thrust. Or they can enter extended ranges that meander back and forth without direction. Movement frequently stops dead in its tracks when price rises into a falling band or drops into a rising one. Sideways bands can appear in both rangebound and trending markets. Price often fails to reach new high or low territory until bands expand to clear the path. In many ways, Bollinger Bands predict time better than they predict price.

Buy Signal: The top Bollinger Band rises toward a test of the intraday high as Worldcom drops. This sharp divergence signals the eventual breakout after price finally reverses off of the bottom band. Watch band slope closely when bars return to test important highs or lows. It often reveals the time and force needed to push price through a S/R barrier.

The skilled eye watches constricted bands in real-time to estimate the buying or selling force required to push them out of the way. They work extremely well during the second test of an important high or low. When markets finally break out, expanding bars often shoot into the band's edge where congestion forms a flag until the BB allows further movement. Bands constrict tightly around narrowing price in sideways markets. Apply NR7 methodology here to anticipate an impending positive feedback event.

Bollinger Bands signal early warning of trend change. Sharp price movement forces bands to expand outward. When these active markets finally turn sideways, the bands slowly tighten and roll toward price. Time passes and the BB door closes on rapid vertical movement. Experience enables the swing trader to quickly estimate the time required before bands will tighten and plan accordingly.

Strong buying or selling may push price well outside a band. A tall bar can even print completely through the barrier in extreme conditions. General tactics suggest that violent reversals often follow these major band violations. But trading against these events carries risk since markets can print a short series of these volatile bars before the reversal takes place. Also note that this price action rarely occurs during intraday markets, except at the open.

Reduce risk by dropping down to the next lower time frame and waiting for a reversal there before executing a countertrend position. Odds also improve if the thrusting bars run into other forms of S/R that allow cross-verification for the entry level. Stay defensive during the trade. Once price returns within the band's limits, the underlying trend can reappear quickly unless the pullback generates other reversal signals. Look for Dark Cloud Cover or a similar candle pattern that fills any gap created by the bar outside the band. This complex setup can produce windfall profits if managed properly.

Swing traders work the quiet middle ground of Bollinger Bands for consistent profits. Build strategies that enter countertrend positions at one band and exit at the other. These swing setups face far less whipsaws than breakout entries at band extremes. Keep in mind that the center band presents a natural profit obstacle that needs special consideration when calculating reward: risk. Make sure a safe exit near this center point still produces a decent profit for the trade.

Multiple Support-Resistance: A broad range sets up profitable swing conditions for KLA-Tencor. This 13-bar Bollinger Band combines with simple horizontal S/R to uncover natural reversal zones at band extremes. Enter a countertrend position when the prior bar prints a candlestick reversal outside the band line. Wait for a break of the center band if no clear signal arises. Exit if price does not expand quickly in the other direction or if the signal fails and the candle shadow gets taken out. Watch S/R closely for positive feedback that will eventually carry price out of the sideways market.

Use multi time frame Bollinger Bands to avoid expensive trend relativity errors. Look at the same market through 3 different time frames. This corresponds to one above and one below the chart that aligns with the holding period. Each setting produces a different range of band extremes and relative price location within the indicators. Match reward: risk to the central time frame but observe all intervening S/R on the other charts. Consider whether the holding period allows enough time to mount barriers and reach targets at other band levels.

Keep in mind that all bands change dynamically in response to price. This allows continuous feedback that shifts target values with each bar. Experience with this powerful indicator helps swing traders anticipate how it will move. The longer that price travels sideways, the tighter the bands become. Trend change for the bands themselves first begins with a turn by the band closest to the prior price trend. For example, when an uptrend prints along a top band, expect this side of the indicator to turn down before its twin when price moves into a range or downtrend.

Combine Bollinger Band study with momentum-based indicators. This helps filter directional movement from rangebound markets and improves trade timing. Add MA Ribbons to price and display the MACD Histogram across the lower pane. Price often remains well within band constriction during the early phases of new positive feedback events. As these indicators show rising momentum, shift attention to natural pattern/band breakout levels and look for entry within narrowing bars.

 


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