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Understanding Stock Options Trading
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"I've always been confused about options trading...
at least now I have a better understanding about it!"
Ben Masters
VIC, Australia
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> Technical Guide >
Bollinger bands strategies |
Bollinger Bands Strategies
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The Bollinger Band theory
is designed to depict the volatility of a stock.
It is quite simple, being composed of a simple moving
average, and its upper and lower "bands"
that are 2 standard deviations away. Standard deviations
are a statistical tool used to contain the majority
of movement or "deviation" around an average
value. Bear in mind that when you use the Bollinger
Band theory, it only works as a gauge or guide,
and should be use with other indicators.
Normally, we use the 20-Day simple moving average
and its standard deviations to create Bollinger
Bands. Strategies some investors use include shorter-
or longer-term Bollinger Bands depending on their
needs. Shorter-term Bollinger Bands strategies (less
than 20-Days) are more sensitive to price fluctuations,
while longer-term Bollinger Bands (more than 20-Days)
are more conservative.
So how do we use the Bollinger Band theory?
The Bollinger Band theory will not indicate exactly
which point to buy or sell an option or stock. It
is meant to be used as a guide (or band) with which
to gauge a stock's volatility.
When a stock's price is very volatile, the Bollinger
Bands will be far apart. In the chart below, these
periods can be seen in early March, mid April and
mid May. On the other hand, when there is little
price fluctuation, hence low volatility, the Bollinger
Bands will be in a tight range. This can be seen
in the circled sections in February, late March
and late June.
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Click
here to view a larger updated version of the chart
at Stockcharts.com
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The Bollinger
Band theory provide indicators to measure
the volatility of a stock price.
It is derived from a simple moving average and its
standard deviations. Wide bands indicate
volatile conditions, while narrow
bands indicate stable conditions.
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As
for how we use the Bollinger Band theory, here are
a couple of guidelines.
History shows that a stock usually doesn't stay
in a narrow trading range for long, as can be gauged
using the Bollinger Bands. Strategies include relating
the width with the length of the bands. The narrower
the bands, the shorter the time it will last. Therefore,
when a stock starts to trade within narrow Bollinger
Bands, such as in the circled sections in the chart,
we know that there will be a substantial price fluctuation
in the near future. However, we do not know which
direction the stock will move, hence the need to
use Bollinger Bands strategies together with other
technical indicators.
When the stock starts to become very volatile, it
is depicted in the chart above by the actual stock
price "hugging" either the upper or lower
Bollinger Bands, with the Bands widening substantially.
The wider the Bands are, the more volatile the price
is, and the more likely the price will fall back
towards the moving average.
When the actual stock price moves away from the
Bands back towards the moving average, it can be
taken as a signal that the price trend has slowed,
and will move back towards the moving average. However,
it is common for the price to bounce off the Bands
a second time before a confirmed move towards the
moving average.
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The longer
a Bollinger Band remains narrow, the more
likely a sudden price movement
will occur. The wider a Bollinger Band becomes,
the more likely the price will move back
towards the moving average.
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As
usual, and for the Bollinger Band theory in particular,
it should be noted that individual indicators should
not be used on their own, but rather with one or
two additional indicators of different types, in
order to confirm any signals and prevent false alarms.
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| All stock options trading
and technical analysis information on this website is for educational
purposes only. While it is believed to be accurate, it should not be considered
solely reliable for use in making actual investment decisions.
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