Bollinger Bands (BBs) have long been a controversial tool amongst technical analysts. Not because of how they work, or what they’re intended to do, but because of how many traders use them as the crux of their swing trading methodologies.
Created by John Bollinger in the early 1980s, Bollinger Bands are a set of lines plotted two standard deviations (both positively and negatively) away from a simple moving average (SMA) of an underlying asset’s price. Variables can be tweaked to adjust how the BBs look on a chart, but in general, most traders use a 20-period SMA.
Much like stochastic oscillators, BBs are often used by technical analysts to determine whether a stock is oversold or overbought, as evidenced by contact (or near contact) with either the upper or lower band.
Roughly 90% of a stock’s price action will occur between the BBs, and breakouts above or below the bands are typically the result of a major event. Often times, after lingering outside of the bands for a few sessions, share prices of a “breakout stock” will swing back into the normal range of the BBs.
For that reason, BBs have become extremely popular. They offer a clear visual on the charts of where “no man’s land” exists for the price of an asset, and over time, they’ve been proven quite accurate.
Just enable BBs on your favorite charting software (or website) and look at how they’ve done over the past few months. Most of the time, stocks will stay within the limits of the upper and lower bands.
But critics of BBs claim that they form bad habits, and worse, can lead traders into predicting unsubstantiated trend reversals. “Timing the market” is extremely difficult, even for expert traders, and many investors use BBs for just that.
And in that case, the critics are absolutely right – BBs should not be the basis for ANY trading method, nor should they be used exclusively to headhunt trend reversals.
But that doesn’t mean that BBs aren’t still highly useful in confirming (not finding) trade setups.
Here’s a great example of what I mean:
In the weekly candlestick chart above, you can see both the upper and lower bands, with a light blue shaded area in-between. This is the range in which approximately 90% of a stock’s price action will take place, like we talked about before.
In this chart, we’ve hidden the 20-SMA (which is usually displayed in the middle of the BBs) in order to show the 50-week moving average, an indicator I like using more than the 20-SMA for finding trade setups.
GLW, without the BBs present, looks like a great opportunity to go long. It’s set 2 higher lows since mid-2018, and has shown a history of quick, whipsaw movements.
But when you consider what’s going on at the lower band, this setup seems even better. The last time GLW traded down to the lower BB, it took off like a rocket once the high of that week was taken out by a little more than 1%. The same thing happened back in early-2018 (not pictured), however it took longer to get going.
This week, you can see that the exact same thing could happen. GLW smacked right into the lower BB, and should the current candlestick close at around the same price, we’ll have a weekly close above the last 3 bars. Better yet, the 50-week moving average is trending up (albeit slightly), showing us that GLW is currently on a long-term uptrend.
All those variables listed above, even without the BBs plotted on the chart, make this look like an excellent trade setup. But when you add BBs into the mix, you’ve got another green light to go long at $31.00 – a little more than 1% above the current weekly high.
So, while many traders often will rely too heavily on BBs to make their trading decisions, that doesn’t mean they aren’t still a very useful tool – one that can confirm new trade opportunities in a way that’s easy to see on the charts, even for novice traders, who need all the help they can get when first starting out.
