Every investor is looking for the perfect combination of analytical tools to forecast the stock market. There are signals that indicate a stock is cheap and ready to soar.
On the other hand, seeing a red flag can help you sell for maximum value and escape with a gain. For example, one indicator used by Warren Buffett suggests a major correction is coming soon.
One market strategy that you will find beneficial is the use of Bollinger bands. Read on to learn how to use Bollinger bands to maximum stock market returns.
What Are Bollinger Bands?
Bollinger bands set a trading range for a particular stock. If the share price falls outside this range it indicates that the stock is overbought or oversold.
Bollinger bands are based on statistical analysis using the mean and standard deviation of a moving average. The Bollinger band ranges are established by calculating the standard deviation above and below the mean.
Some investors like to sell stocks when the share price hits the top of the Bollinger band. Conversely, these investors will purchase a stock when a share hits the lower band.
What Is the Risk of Exclusively Using this Strategy?
Stock market experts do not recommend exclusive use of this strategy. In fact, the founder of this strategy, John Bollinger, did not consider his band to be a buy or sell signal.
Instead, Bollinger viewed the band as a “tag” and should only be in conjunction with other signals. The investment risk is that the share price follows along the outer ranges of the band. The experts refer to this as walking the band.
This event will result in considerable investment losses. For instance, consider that you buy a stock when it hits the lower band.
However, it is conceivable that the share price continues to walk the band on a downward trend line. If this occurs, the stock price will continue to drop after you bought it.
A similar situation can occur at the top of the band. In this case, you consider the stock overbought because the share price is at the top of the band. Unfortunately for you, the share price continues to walk the band at the top of the range and you miss out on major gains.
What Is the Best Way to Use Bollinger Bands?
As John Bollinger suggested, the best way to use Bollinger bands is as a tag. Bollinger bands are a great way to spot a trend.
The trick is assessing the strength of an upwards or downwards trend. Bollinger bands can be effective when used with another analytical tool like Moving Average Convergence Divergence (MACD). Some websites have apps or send e-mails to notify you when a signal is flashing.
Another effective way to trade is to use Bollinger bands in conjunction with volatility analysis. Bollinger bands contract when volatility is low. When the Bollinger bands indicate a buy or sell action at the same time as low volatility, it reinforces the decision to act.
How to Use Bollinger Bands – Wrapping It Up
Bollinger bands are an effective analytical tool to add to your investment toolbox. They are helpful for spotting market trends.
If you want to learn more about how to use Bollinger bands or other Forex signals, check out our website for additional information.