(6) Producing Fake Signals From Time-To-Time
It is one of the most important limitations of Bollinger Bands in technical analysis. As stated earlier, ideal setting of Bollinger Bands usually vary from market to market. It is even required to be modified over time when trading the same stock or bond.
However, you set up the indicator & it seems to be working well, there will still be certain periods when it can produce false signals.
For example, when stock volatility is low, the bands tend to contract. It is especially true if the price is moving sideways. During these times, price may bounce off the upper & lower band.
In such a case, it isn’t necessary a reversal signal. It is due to the fact that narrow bands are just closer to the price & thus likely to be touched.
On the other hand, when outer bands are breached on intraday basis then it is not an indication of a good breakout. It is because closing prices are more important when drawing Bollinger Bands. You should better analyze such patterns along with additional indicators for clarity.
Generally, false signals are formed more in number as compared to true signals. The false signals are commonly found in illiquid scripts, intraday trades, gap up opening then revert back within boundaries, unexpected events & many more.
Thus, traders who make positions at such critical levels only after confirmation are mainly on profitable side.
(7) Prevailing Trend May Not End Even After Breaching Outer Bands
It is one of the most shocking criticisms or limitations of Bollinger Bands in technical analysis. The price of a script or bond is likely to move within Bollinger Bandwidth for 85%-90% of the case.
It is because when prices are touching or breaching upper band then it could be an overbought condition. However, when prices are touching or breaching lower band then it could be an oversold condition.
But, overbought conditions can extend further in a strong uptrend. Similarly, oversold conditions can extend further in a strong downturn.
It is due to the fact that breaching of outermost bands takes a lot of strength. Therefore, it should always be accompanied with a strong reason such as specific macro or company related events. In such a case, the trend must be closely watched to find ideal entry/exit points.
- Bollinger Bands Limitations: Azureedge.net