When identifying trading opportunities traders should follow two basic guidelines:
Identify the direction of the trend
In an up-trending market, look to buy
In a down-trending market, look to sell
Identify the right times to buy or sell
One way to do this is with Bollinger Bands
Bollinger Bands
A technical indicator that utilizes a combination of simple moving averages which can help a trader compare volatility and relative price levels over a period of time.
The outer bands are often used to help traders time an entry or exit point for a trade
The default settings in most charting packages will have the outer bands two standard deviations away from the 20 period SMA line found in the middle
To increase the reliability of the signals the setting can be changed to three standard deviations
Standard Deviation is a calculation used in statistics to measure volatility
Therefore as price action approaches the outer bands, which can be considered more extreme price levels, traders often anticipate the price-action will reverse around these extremes and move back towards more natural levels.
Thus the outer bands are often used to identify entry and exit points
Traders also use Bollinger Bands to note a potential break-out situation
As the market trades in a range-bound situation the bands will move close together
The closer they print, the higher the likelihood of a breakout
While this indicator does not tell us the direction of the breakout, just being aware of the possibility can help the trader