Bollinger Band Squeeze
tl;dr
A Bollinger Band Squeeze occurs when the price of an asset consolidates and the Bollinger Bands tighten, signaling a potential breakout. Traders look for the price to move above the upper band for a bullish move or below the lower band for a bearish move. This is often a signal of an impending increase in volatility. Confirm with volume and other indicators to improve the accuracy of your trades.
Definition.
A technical pattern that occurs when Bollinger Bands contract, indicating low volatility and a potential breakout.
Real-World Example.
A Bollinger Band Squeeze is a trading signal that occurs when the price of an asset is consolidating, causing the Bollinger Bands to tighten. The Bollinger Bands are a technical analysis tool that consists of a middle band (usually a simple moving average) and two outer bands (which are typically two standard deviations away from the middle band). When the price is moving in a narrow range, the bands contract, indicating a period of low volatility.
For example, imagine a stock that has been moving sideways for a while, with the Bollinger Bands narrowing as the price moves within a tight range. Traders often view this as a Bollinger Band Squeeze, anticipating that the market is preparing for a breakout. If the price breaks out above the upper band, it could signal a buying opportunity. Conversely, if the price breaks below the lower band, it could signal a selling opportunity.
How to Use the Bollinger Band Squeeze in trading.
- Watch for the Squeeze: A Bollinger Band Squeeze occurs when the bands tighten, indicating a period of low volatility. This could be an early sign that the market is about to break out in either direction. Pay attention to this squeeze by monitoring the distance between the upper and lower bands.
- Breakout Direction:
- Upper Band Breakout: If the price breaks above the upper band, it may indicate that a bullish trend is starting, and a buying opportunity could be approaching. This suggests that the market is moving from a period of low volatility to high volatility, often leading to a price surge.
- Lower Band Breakout: If the price breaks below the lower band, it may indicate that a bearish trend is starting, and a selling or short-selling opportunity could be near.
- Confirmation with Volume: A breakout from a Bollinger Band Squeeze is often more reliable when accompanied by increased trading volume. A higher volume on a breakout indicates that there is strong interest in the move and helps confirm the validity of the signal.
- Risk Management: While a Bollinger Band Squeeze can be a strong signal for potential price movements, it’s important to use other tools, like RSI (Relative Strength Index) or MACD (Moving Average Convergence Divergence), to confirm the direction of the breakout and manage risk. This helps avoid false signals where the price may break out temporarily before returning to the tight range.
- Setting Targets: After a Bollinger Band Squeeze and breakout, set price targets based on previous highs or lows or use a trailing stop to lock in profits as the price moves in your favor.
