Market volatility usually indicates the shifting price points and is a significant factor that determines whether a trade will turn a profit. Bollinger bands are one of the most important indicators of market volatility to use in 2020.
Simply put, market volatility affects price trends. A volatile market will have the prices of trade options indicate an unpredictable direction because of their increased range.
Highly volatile markets exhibit greatly varying prices such that traders often find it challenging to predict where an option’s value will settle. As such, volatile markets are harder to trade in.
Think of volatility as a tool that measures how the market moves. This draws from the influence market volatility has on the value of any stocks and other trading options. That is to say that you will understand how the price of a stock or currency fluctuates using the volatility feature.
Understanding Volatility Indicators And Why They Matter When Trading
Volatility indicators come into the picture as they help to provide a bigger picture regarding the market. Traders use different strategies to buy and sell options. The state of the market often determines these approaches. Hence the need to understand volatility which should help you gauge whether the market trend suits your trading needs.
As markets generally undergo high and low volatility stages periodically, traders can determine a state of low volatility to trade. Such a situation favors those seeking predictable markets for long-term investment.
Because markets typically abide by a laid-down trend of high and low volatility periods, traders can determine when the changeover will take place. This breakout point indicates a market reversal and would be an excellent point to consider trading at.
Additionally, strong trends are generally the safest investment option. This is because the chances of price changes are unlikely. Volatility will show whether it is viable to follow a pattern by measuring the price range and hence the market stability.
There are several indicators of volatility traders can use that include Bollinger bands, Average True Range (ATR), MT4’s Momentum Indicator and the Keltner Channel. Bollinger bands is the most popular indicator of market volatility. It is one must-have indicator to include in your trading strategy.
What Are Bollinger Bands
Bollinger bands are a market volatility indicator that is visually represented by three bands. The lines, outer, lowered, and middle bands run parallel to the price chart.
Bollinger bands are set to follow a 20-period simple moving average (SMA). The general configuration for this set of bands, upper and lower band, tracks the 20 period SMA allowing two standard deviations. Therefore, such a setup is given the moniker the 20, 2 Bollinger Band.
The 20-period moving average acts as the reference point when measuring pricing points. A price close to the upper Bollinger band is considerable and not worth indulging in. This is because it lies two standard deviations above the SMA.
On the other hand, a price of 2 deviations from the SMA is considered cheap. Because trading is about chasing a profit, buying when the value of an option has fallen is the norm. However, because the price is low doesn’t mean you should go for it. On the contrary, this might be the price position for way longer than you expected and hence run the risk of failure.
Features Found In Bollinger Bands
The main characteristic you will get on Bollinger bands is the trio of lines. The upper, middle and lower bands run parallel to each other as they follow the price chart.
Secondly, these bands are never at equidistant points from one another. The space between them keeps changing through time owing to price changes on the market for stock or currency. As such, the variations in-between the lines indicate expansion and contraction of Bollinger bands.
Expansion and contraction are the first signs of market volatility changing. As market volatility is derived from market prices, their shift in value causes a similar change along with Bollinger bands. For instance, a contraction movement in a Bollinger band is indicative of low volatility in the market. With falling volatility, prices tend to move in limited ranges signaling an impending expansion in the bands.
The Basics For Interpreting Bollinger Bands When Trading
1. Expansion And Contraction
Bollinger bands exhibit two significant types of deviation, which are an expansion and contraction. In both scenarios, the distance between the upper and lower bands varies as determined by the level of market volatility.
During an expansion, the lines move away from each other and vice versa when a contraction takes place.
An expansion scenario depicts an increase in market volatility. This is where the price range faces increased activity and as such outer bands move away from each other. The space between Bollinger bands increases as the upper and lower lines disperse in opposite directions from each other. This indicates an increase in market volatility
2. Walking The Bands
When the price trend is strong, the price tends to follow either the upper or lower bands. This phenomenon is then referred to as Walking the bands.
What it means is that traders can note when the price is hugging one Bollinger band to conclude the strength of the market trend. Naturally, the price rarely moves below the middle line.
When trading, most market situations seldom last forever and are often concluded as soon as they began. Traders are trained to take full advantage of such cases to turn a profit.
So it then follows that after a period exhibiting a strong trend is witnessed, the price begins to move sideways and the range contracts. A contraction in the Bollinger band confirms the shrinking range and a reduction in market volatility.
When contraction sets in, the probability of a volatile breakout in the price increases, and traders often know too well what follows next. At this point, prices will move along the lower Bollinger band. This move is termed as walking the band in the downtrend.
The basics around Bollinger bands revolve around volatility. However, as you can see, when walking the band, Bollinger bands can help indicate price trends and eventually go a long way in aiding trading decisions.
The Potential Of Bollinger Bands During Trading
For traders tracking the price chart trends, Bollinger bands will indicate high and low market volatility as they expand and contract in opposite directions. Markets regularly alternate between instances of high and low volatility and traders can then capitalize on breakout points based on this set of indicator bands.
The Bollinger bands indicator cuts across several parameters in trading and stands out as an all-inclusive volatility indicator. This is because the bands indicate not just market volatility but also price trends.
Additionally, Bollinger bands have also been used to gauge where support and resistance may be injected. Support and resistance allow traders to confidently engage the market by providing buying and selling signals. As such, you will effectively understand whether the price is right and allows you to enter into the market
Therefore, Bollinger bands are a valuable trading indicator. In trading, this set of bands is a sort of Jack of all trades among volatility indicators. The benefit of having a tool that cuts across different fields is the ease of operation that follows.
With Bollinger bands, forget about crowded charts. This indicator holds its own pretty impressively when stacked against other indicators. This is attributed mainly to its multi-functional nature hence eliminating the need for a busy trading chart.
While the indicator is not a foolproof method of determining your profitability, it gives you a head start when forming a bigger picture of the market of interest. As such, when you combine Bollinger bands with other momentum-based tools, your market understanding will be significantly improved. Thus, you will be able to make conclusive trading decisions from the wealth of information on hand.