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How To Use Bollinger Bands To Time Stocks

Updated on August 1, 2016

What are Bollinger Bands?

Bollinger Bands are a technical analysis indicator, meaning that the calculation is based off of price movements and not financials of a specific company. It is calculated by taking the simple moving average and finding lines that are a specified standard deviation above and below the moving average. The most common Bollinger Band is the 15-2 which simply means the moving average is calculated over the past 15 days and the lines are 2 standard deviations away from the moving average. The Bollinger Band can be expressed as a price range or the current market price can be expressed as a percentage of this range. Both are valuable tools for timing stocks.

Take a look at this chart of Autonation which shows how Bollinger Bands show when the stock will rise and fall. As the price hits the bottom of the Bollinger Band it bounces up in price until it reaches the top of the band and returns to a lower price. Someone trading this stock is able to make much more money by timing with Bollinger Bands rather than buying and holding

Autonation Bollinger Bands

Autonation's stock price oscillates but tends to always stay between its Bollinger Bands.
Autonation's stock price oscillates but tends to always stay between its Bollinger Bands. | Source

How To Use Bollinger Bands

While it may seem simple to just buy at the bottom of a Bollinger Band and sell at the top, it is really much more complicated. These bands are what I like to call an "timing indicator." They should probably not be used to pick stocks but rather for choosing when to buy and sell a stock for maximum profit.

KEYS FOR BUYING

  • Never buy a stock that is outside of the Bollinger Band
  • Be cautious of buying when the price is 80% or higher of the bands
  • Don't buy until you see a breakthrough (explained below)

It is true that you to time a stock you need to be buying near the bottom of a Bollinger Band, but risk/reward of buying in this territory is dangerous and the gains are not worth the risk. Simply wait to see if there is a breakthrough. This can be seen by looking at a number of other different indicators such as resistance or more simply by waiting until the price has bounced off the bottom to a suitable percent. An estimation of this percent is tricky because it depends on the history of the stock, but a rule of thumb is 20%.

The Bubble Play

The Bubble Play is extremely effective at predicting huge movements in a short amount of time
The Bubble Play is extremely effective at predicting huge movements in a short amount of time | Source

How to Use the Bubble Play

The Bubble Play is all about huge price movements in a short amount of time which is which it creates the bubble shaped Bollinger Bands. Why does it do this? Without going into the psychological analysis of traders and price movements, it is basically because of how people often use resistance or support as an indicator. Traders look for price ranges in which the price is consistently fluctuating. The longer it fluctuates in a smaller range, the larger the price movement will be once it breaks out of that range. Notice what happened to Perrigo in the chart above. The Bollinger Bands appear to close in on one another until finally they pop. But the key is not that it popped, but figuring out which direction it will go. The squeezing Bollinger Bands are an indicator that you should keep a tight eye on this stock. If you saw this play coming you would've noticed when the first drop after the squeeze had occurred and you could have shorted the stock for a nice profit in just a few days.

Mastering Bollinger Bands

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