Using Bollinger Bands to Determine Whether to Buy Stocks

!±8± Using Bollinger Bands to Determine Whether to Buy Stocks

For long-term trading decisions, using Technical Analysis may not make much sense. However, when purchasing equities it always makes a great deal of sense to make sure one is not entering into a large position (not to be confused with a dollar-cost-averaging approach) at the worst possible moment, which is normally when the security price in question is at its absolute highest.

Ultimately, that is the investor's primary goal: to make sure that the price at which a large block of shares is being purchase is not at the absolute peak. Ideally, it makes the most sense to purchase in a valley or when the security price in question is at a low, but in reality this is difficult if not impossible to time. Therefore, using an optimal stock price is what an investor aims to do.

There are several technical measurements that one can use when determining whether a security's price is properly priced both in terms of not being "overbought" (i.e. at a peak) and in ensuring that is still some room for future growth (i.e. not on its way down).

One of the most popular technical tools available to a customer is the Bollinger Bands. These bands will measure deviation as well as chart the Moving Average for that security. As the bands widen, the security is believed to be experiencing heightened volatility and the belief is that it will return to more-normal levels, which is the Moving Average.

The best time to buy using the Bollinger Bands as an indicator is when the security price is just above or about to touch the Moving Average after touching or retracting from the lower Bollinger Band. (Of course, the idea is that the trend remains favorable). As well, if the band are narrowing, it suggests that volatility has left but "tension" is working its way back and there will likely be another burst.

Provided that fundamentals support it, once the security price touches or crosses the Moving Average, the investor should purchase. In time, volatility will return and the security will jump, causing the bands to widen and the price line to cross over or touch the upper band. Once this happens, short-term traders or swing traders may wish to sell and short the security. Longer-term, bullish investors might want to protect their position and gains with a put option. Either way, the stock will return toward the moving average and come down off its highs (most likely, the moving average will start to edge upward and the security will move sideways or even down marginally).

As a technical analysis tool, the Bollinger Band provide some reassurances to the long-term investor that the position in question is not being entered during a terrible period. In fact, the bands can provide a good insight into the timing of a purchase, particularly for the long-term and secondarily for the short-term so that the investor knows what to expect.