# Brin channel: basic concepts detailed

2023-11-15
Summary:

Bolling channels include upper, middle and lower tracks that provide signals based on price volatility and trends. Channel widths reflect volatility, and a break above or below the rail may generate a buy or sell signal.

In fact, no matter whether a business is buying raw materials or a housewife is grabbing the budget for this month's household expenses, most of them will grab a cushion in order to avoid a sudden increase. Some people who are good at statistics will calculate the standard deviation based on past figures and then add 0.5 to two standard deviations of the reserve amount.

In the stock market, if using the daily closing price standard deviation to see the moving average limit, the range calculated by the two sets of data can assist investors in grasping the magnitude of the recent changes in stock prices and then as the basis for entry and exit. This is the basic concept of Bollinger bands, which we are going to introduce to you today.

Bollinger Channel

It is a commonly used technical analysis tool to help analyze the price movements of stocks, foreign exchange, commodities, and other assets. Developed by John Bollinger in the 1980s, it is constructed based on statistical principles and moving averages.

It consists of three main lines: the upper rail is the upper line of the channel, usually located above the price line. The middle rail is the middle line of the channel, usually the simple moving average (SMA) of the price. The lower rail is the lower limit of the channel, usually located below the price line.

Its primary use is to measure price volatility, determine price trends, and spot potential breakout signals. First, the width of the channel varies with price volatility. A wider channel indicates increased volatility, and a narrower channel indicates less volatility. And when price is in the upper half of the channel, it may indicate an upward price trend; when price is in the lower half, it may indicate a downward price trend. Finally, a potential buy or sell signal may be generated when the price line breaks above or below the upper or lower rail.

 Concept Description Definition Technical analysis tool developed by John Bollinger to measure price volatility and trends. Uses Measure price volatility, determine trends, spot breakout signals, and identify support and resistance levels. Upper Rail Also called a pressure line, it is a multiple of the standard deviation of price plus the mid-rail. Middle Rail It is generally the 20-day Simple Moving Average (SMA) of the intervals. Lower Rail Also known as a support line, it is the mid-rail minus a multiple of the standard deviation of the price. Signal A price break above the top rail is a buy signal, and a price drop below the bottom rail is a sell signal.

Principles of Bollinger Channel

It is an analytical tool made up of three lines.

The first line in the middle, generally known as the mid-rail line, is actually the 20-day moving average. In general, most investors are accustomed to the 20-day moving average. Of course, if investors want to match the average of different calculators, analyzing in fact is also possible.

The upper line, called the pressure line, is calculated by adding two standard deviations to the center line. On the contrary, the line below, which is drawn by subtracting two standard deviations from the center line, is generally called the support line. The block around the pressure and support lines is known as the Bollinger Bands network.

After calculating these values and drawing these lines, what is the significance? There is a little bit of a simple statistical concept involved here. Based on the normal allocation of plus or minus one standard deviation, the odds of being covered are about 68%, and plus or minus two standard deviations is a whopping 95.4%.

According to this concept, it is not so common for daily price movements to go outside the channel, i.e., outside plus or minus two standard deviations, in terms of probability. But because of this, when it happens, it is a very important signal for investors.

How to look the Bollinger Channel Bands

The first thing to look for is price position, which means looking at where the price line is relative to the channel. When the price line is in the upper half of the channel, it means that the price may be a bit on the high side and may be overbought, so it could be a potential sell signal. And when the price line is in the lower half of the channel, it may indicate that the price is at a relatively low level and there may be over-selling, so it could be a potential buy signal.

Then, look at the width of the channel, which depends on the spread multiplier setting. A wider channel indicates that prices are fluctuating a bit too much and that there may be uncertainty in the market. A narrower channel, on the other hand, indicates that prices are less volatile and the market may be more stable.

Next, look for breakout signals. Channels often signal breakouts. When the price line breaks above the upper rail, it indicates that there may be a potential uptrend, so it could be a buy signal. And when the price line breaks through the lower rail, it may indicate a potential downtrend, so it may be a sell signal. But remember, breakout signals should be used in conjunction with other indicators and trend confirmation to minimize risk.

Again, confirm the trend. If the price line is in the same direction as the channel, that may indicate trend strength.

Finally, remember to analyze multiple time frames. Consider using different time frames to confirm signals. For example, look at the trend in the long-term time frame and then look for entry points in the short-term time frame.

 Observation Points Significance Narrower channel width The distance between the upper and lower rails of the channel narrows. Reduced mobility Price fluctuations are relatively weaker and the market becomes relatively calm. Consolidation Stacking It may be the bottom of the market entering a period of consolidation. Breakout trade A price breakout will occur after the channel narrows and the market will re-trend. Trade with caution Low price volatility makes trend direction challenging to determine. Confirmation of other signals Combine with other indicators to reduce trend signal risk.

Optimal Parameters for Bollinger Channel

Its parameters can be adjusted for different markets and trading strategies. The optimal parameters depend on the trading objectives, time frame, and risk tolerance and need to be determined through experimentation and backtesting. The main parameters are:

Type of Moving Average: The mid-rail is usually a moving average of the price, and different types of moving averages can be chosen, such as simple moving average (SMA), exponential moving average (EMA), or weighted moving average (WMA). SMA is the most common choice, but it can be chosen according to the overall preference.

Moving Average Duration: The moving average duration of the mid-rail can be set based on the time frame of the trade. Common durations include 20. 50. and 200 days. Shorter durations are good for short-term trading, and longer durations are good for long-term investing. Choose a term that suits your trading objectives.

Standard Deviation Multiplier: Typically, the standard deviation multiplier is set to 2. This means that the top and bottom rails are the distance between the middle rail plus or minus two standard deviations. This is a common setting and can also be adjusted based on demand and market volatility.

Market characteristics: Different markets and asset classes may require different parameter settings. Certain markets may be better suited for short-term trading, while others may be better suited for long-term investments. Therefore, parameters may need to be adjusted depending on the specific market and asset being traded.

Risk tolerance: Risk tolerance is another key factor. If the tolerance for risk is low, more conservative settings may be chosen to mitigate volatility. If the tolerance for risk is high, the parameters can be set more flexibly.

 Concept Description Definition The 5-day simple moving average is an average price level based on the most recent closing price. Uses Measure short-term trends, set support and resistance, and determine the timing of entries and exits. Trend Analysis Price above average, short-term trend up; price below simple moving average, short-term trend down. Support and Resistance There are support or resistance levels. When price approaches the 5-day SMA, it may bounce or resist. Cross Signals A buy or sell signal is generated when it crosses a long-term moving average, such as the 50-day SMA. Short-term activity Is more sensitive to short-term price volatility

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment, or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction, or investment strategy is suitable for any specific person.

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