Understanding Bollinger Bands

Bollinger Bands where created unsurprisingly by John Bollinger in the 1980’s. Bollinger Bands are a piece of technical analysis used to determine the highness or lowness of the current price relative to previous trading. The upper and lower Bollinger Bands lie one standard deviation from the current moving average. Generally the default choice for calculating the Bollinger Bands is a simple moving average, but other types of moving averages can be used. The purpose of Bollinger Bands is to give a relative definition of high and low. Prices at the upper band are by definition high and those at the lower band by definition low. 
How Bollinger Bands are used among traders vary greatly. One typical strategy is to Buy when the price hits the lower Bollinger and sell when the price returns to the moving average. While other traders buy when the price breaks through the the upper Bollinger and conversely sell the instrument when the price breaks through the lower Bollinger band. Bollinger bands uses are not just used to limited to those trading stocks and commodities. Some option traders, sell options when Bollinger Bands are historically far apart and Buy options when they are historically close together, in both instances the options traders are expecting the volatility to revert back to the historical norm for the particular instrument.  
The effectiveness of Bollinger Bands is highly contentious with their being seemingly conflicting evidence. A recent study on the effectiveness of Bollinger Bands on the Chinese Markets found that such a strategy could be used to make a profit even after trading costs where considered. Others advocate the use of Bollinger bands with stop losses as an effective strategy to trading the markets. But there is still no clear consensus regarding the effectiveness of Bollinger bands as a trading tool.


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