Learn To Use Moving Averages & Bollinger Bands?
Moving averages are a very popular tool among the traders because they are a lagging indicator of the price action. Short and long term trends are easier to identify using moving averages.
MAs are calculated on the traders specifications. They can be formatted to different style of trading and time frames. For example, in case you want to use a 90 time frame moving average, the prices of the last 90 times frames is added together and divided by 90.
A moving average can be calculated based on the opening, high, low or closing price within a time frame. Since the closing price is the most important price, most traders prefer to use the closing price. There are three types of moving averages. First one is the Simple Moving Average. Second is Weighted Moving Average and the third is the exponential moving average.
The simple MA is simply calculated by dividing the price in each time frame by the number of time frames as the name suggests. A weighted MA places more weight to the current prices as compared to the prices in the last few time frames. In an exponentially smoothed MA, the chart is exponentially smoothed out with less emphasis on the prices in the latter time frames.
Another important technical indicator is the Bollinger Bands. What are Bollinger Bands? These are bands plotted at a standard deviation above and below a moving average. The base of a band is moving average. The bands width is determined by volatility. The standard deviation is a measure of volatility so the bands are self adjusting. They widen during volatile markets and contract during less volatile periods. Bollinger bands bracket almost 90% of the market action.
Bollinger bands have many useful characteristics. Knowing when the prices are high and low, a trader can make rational investment decisions by comparing price action with the action of other indicators. They are curves drawn in and around the price structure. This provides relative definitions of high and low.
Bollinger bands can be applied to mutual funds, forex trading, futures, indices etc. As volatility lessens, sharp price action tends to occur as the bands tighten. A continuation of current trend is strongly expected when the price moves outside the bands.
A move that originates at one band tends to go all the way to the other band. When bottoms and tops made outside the bands are followed by bottoms and tops made inside the bands, reversal of the trend is highly likely.
When the bands are flat and narrow, this indicates that price volatility is lower than in previous time periods. The 10% price action outside the bands is most likely going to approximate areas where prices will return to within the bands.
When the bands begin to flare and widen, this indicates increased volatility and start of a new strong trend. Wide bands are usually taken as an indication of a very strong move.
