Trading penny stocks can be a very lucrative form of trading if certain guidelines are met. One of those guidelines is having the proper tools to evaluate and chose winning penny stocks. Charting software is an important component of a trading system and within the charting software there are various indicators that a person can use when considering a penny stock investment. This article will cover one of those indicators, Bollinger Bands.
Developed by John Bollinger, Bollinger Bands are an indicator that allows traders and investors to compare volatility and relative price levels over a designated time period, a relative high or low in the instrument being traded. Two important factors are derived from the Bollinger Bands which are bandwidth, a relative measure of the width of the bands from each other, and a measure of where the last price is in relation to the bands. Having evolved from the concept of trading bands, Bollinger Bands can be used to measure the low or high of the price relative to previous trades, indicated on the underlying chart.
Since their introduction, few indicators have helped traders as consistently as Bollinger Bands and the use of Bollinger Bands varies distinctly among traders. The use of Bollinger Bands is not confined strictly to stock traders, options traders often sell options when Bollinger Bands are far apart or buy options when the Bollinger Bands are close together, in both instances, expecting volatility to return back to the average volatility level for the stock or option.
Closing prices are the prices that are most often used to calculate Bollinger Bands. In addition to identifying volatility and relative price levels, Bollinger Bands can be combined with price action and other indicators to generate signals helping identify potential significant moves. By themselves, Bollinger Bands have two main functions which are to identify periods of low and high volatility as well as to identify time periods when prices are at unsustainable and extreme levels. Bollinger Bands do not give absolute buy and sell signals, and most traders agree that the bands indicate if price is at a relative high or low.
Many traders utilize Bollinger bands to determine the volatility of a stock movement and identify the time frame when the current trend of a simple moving average may be coming to an end. If the two Bollinger bands violently move apart and start moving in opposite directions, the stock has made a significant move. Of course this depends on what time frame the chart is being used. A one minute chart, for example, would not be considered an extreme move with Bollinger Bands. However, a 15 minute chart or daily chart with wide bands surrounding the candlestick would be considered a significant move. It should also be noted, when price is trading near the lower or upper Bollinger band line, there is a possibility that the current trend may be reversing. In other words, when price reaches these extremes they should be considered overbought and oversold.
Over the past twenty five years, traders have considered Bollinger Bands to be the most important and reliable tool for determining expected price action, with almost all trading software platforms including Bollinger bands as one of the primary indicators. Used in conjunction with other indicators, Bollinger Bands can be a powerful indicator to implement into a system designed for trading penny stocks.
Doug Fisher is a frequent trader in the penny stock markets. For more information about trading penny stocks, please visit his blog.
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