Not every price what you see in the market has the same interpretation. The market tries to communicate something different each day with its price actions. Bollinger band will help you to know which price action is weak and which one is strong to drive the market in a particular direction of the trend.
It describes the relative strength of price
Bollinger band basically works on the principle of standard deviation. It is represented by a band comprising of 3 elements
- Upper deviation line
- Lower deviation line
- Mean deviation line
This band envelopes the price movements and helps us to determine when trend variation may take place.
Use and interpretations
With Bollinger band, two possible conditions can be evaluated and the trend can be analyzed.
- When the close price is near to the lower deviation line: This signifies that the market is going in the bullish direction as the deviation of close price is near the upper line which means these are positive deviations.
- When the close price is near upper deviation line: Here the trend is going in bearish direction and are weak to take trend reversal. Here you need to wait for proper signal of trend reversal.
- When the close price is leaving the deviation lines with same price values: The close price is when close to lower deviation line the price actions are weak and have no tendency to take trend reversal. But when the close price starts leaving the lower deviation line the price action become relatively strong despite of same price value and gain the tendency to take trend reversal. You can look at the example illustrated below where the close price where its distance from lower deviation line increases
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This is one of the tremendous used and trusted technical indicator by the day traders. You can use this to verify your trend reversals and make entry-exit