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Assessing Volatility With Bollinger Bands

Bollinger bands are one of the key tools used in modern trading and although each individual trader has their own preferred indicators, Bollinger bands are used often by nearly all traders.

Basic Range Trading

One of the greatest benefits to Bollinger bands is their ability to assess the volatility of a particular security. By accurately analyzing and interpreting this volatility, a trader can make crucial decisions regarding entering and exiting the market and they can also use this information to be fairly confident of future movements in the price of a security.

Volatility With Bollinger Bands

The volatility of a security is the amount of risk surrounding the potential change in price of that security. If a particular security has high volatility its potential price can occur anyway over a large range of values. This means that the security is very risky because it has the potential to change price quickly and dramatically over that large range of values.

This could either work in the favor of a trader with a position in the market or it could work badly against them. On the other hand a security with a low level of volatility is said to be much less risky. This is because its price is only likely to change over a much small range of values and this ensures that no dramatic or sudden changes will occur and the transition in price will be smoother and gradual.

Bollinger bands are excellent tools for measuring and displaying the volatility of a security and this is what makes them so popular amongst traders. The volatility is portrayed to the trader via the width between the upper and lower Bollinger bands.

When the width is very wide and each band is a considerable distance from the moving average line this indicates that the volatility is high and thus the stock is risky.

Alternatively, if the width between the upper and lower bands is narrow and much more constricted than usual, the volatility of that security is said to be low. In this instance the trader can be confident there is less risk involved in entering the market at this stage. This information is easily recognizable and a trader can use it to judge whether they want to enter or exit the market during a highly volatile period or a less volatile period. Similarly traders can also use the width of the bands to judge an imminent change in the market.

When the width between the upper and lower bands is narrow and the volatility is low, this is an indication that the security has been trading within a range for a period of time. Traders can use this information to predict a future change in market price because a security trading within a range and with low volatility will break out at some point. A new trend must develop sooner or later and the narrow bands will indicate this. Once this is recognized a trader can keep aware to a market direction change.

Bollinger bandsĀ are the premier tool for getting an accurate feel for volatility and employing some of the most accurate volatility trading techniques. Check out our website and cut your learning curve in half with our free video series.