Financial Market Fisherman

Jun 05 2008

Using Bollinger Bands to signal tops or bottoms with divergence

Published by Dean at 2:34 pm under Backtest, Discretionary System, Financial Market Fisherman, Mechanical System, Technical Analysis, Trade, Trading Plan, Trading System, Trend

There are quite a few uses for Bollinger Bands in trading and today we’ll look at one of them: Divergence.

Divergence is a common element of oscillating indicators such as stochastics, MACD and RSI to name a few, but the Bollinger Bands can display divergence too.

When divergence takes place several things will happen. In this example, we’ll discuss price making a top and the bollinger bands alerting us to this.

1. First, price will make a high and break above the upper band, and usually quite significantly.

2. Second, price will then head back into the bands, retreating from the high.

3. Third, price will then make a new high but will NOT break out of the upper band.

When you see this series of events, you have bollinger band divergence.

The picture below will give you a visual example of the three events that I have just described. Whether you already use bollinger bands or not, this can be a very useful tool to add to your tool box.