Hi Steemians today I wanted to share an explanation of “Bollinger Bands” a investing tool created by a stock investing expert who studied charts. I have combined multiple different explanations into one, which I hope you will find useful.
This is a investing tool used by many types of investors, but it is especially useful to option spread traders because it shows you where to place your two strikes with the mathematical probability of a successful trade being on your side. And every option trader knows it’s the math which makes or breaks a trade setup.
I think it can be said, without exaggeration that the Bollinger band, invented by John Bollinger is one of the most popular trading price volatility measurements in stock and option trading. Most famous successful traders tell you their secret sauce and then add the phrase : “... and I use Bollinger bands.”
John Bollinger creates this volatility measurement after years of study. But now it looks quite simple. He charted a simple 20-day moving average of the closing price with a band on either side consisting of two standard deviations of the moving average, effectively capturing about 95 percent of the variation away from the average. The bands are, so to speak, moving standard deviations. At some point, every price thrust exhausts itself between these bands.
As the name implies, Bollinger Bands ® are price channels (bands) that are plotted above and below price.The outer Bollinger Bands ® are based on price volatility, which means that they expand when the price fluctuates and trends strongly, and the Bands contract during sideways consolidations and low momentum trends. By default, the Bollinger Bands ® are set to 2.0 Standard deviations which means that, from a statistical perspective, 95% of all the price action happens in between the channels.
Bollinger Bands® are volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes as volatility increases and decreases. The bands automatically widen when volatility increases and contract when volatility decreases.
For an options spread trader we often need the stock to finish above a certain price and below a certain price. The standard deviations from the mean represent large probability percentage zones and two standard deviation price points above and below the market price which represent the 95th percentile in either direction. This means the stock has a 95% chance of closing above the lower strike and 95% chance of closing below the upper strike.
In times of volatility there is enough premium in these far ranges to make a $100 on ten contract and $200 on 20 contracts. If you create an iron condor you can sell both put spread and call spread, nearly doubling your profit. If your brave and attentive you can just sell the options and save on buying the protective options and profit more. The statistical probabilities are on your side. Plus if the market moves against you and your probabilities change you can roll out to the next month, giving yourself more time to be right.
✍️ written by Shortsegments.
