Bollinger Bands: what should you know about this indicator?

Today, it is difficult to imagine financial markets without technical analysis. It allows us to automate different operations in the financial market. In most situations, you don’t even need to understand general laws of how price changes. 

One of such classic and popular tools for technical analysis is Bollinger Bands (BB). It allows us to understand how a particular instrument that we use for trading is changeable. What is Bollinger Bands? 

The definition of the term “technical indicators”

In general, they are tools that can help us automate the process of trading decisions. They are effective for detecting tendencies or predicting them depending on the type of indicator. BB is an example of a tool that can help us understand the trend better. 

This is a trend type of these instruments. However, a lot of beginners don’t understand what it means. Let’s explain this concept. This type of indicator was developed for understanding the main tendency of a certain financial asset, for example, cryptocurrency or money produced by governments of different countries. 

The popularity of this tool isn’t surprising because you don’t need to understand all the laws affecting the price to understand the direction of it in the future. You just need some statistics. All of them can be used not only for creating your personal trading strategy. For example, their signals are in the base of trading robots.

You can earn money not only by trading. For instance, you can create your personal trading system that is automated and sell the trading robot. But you can’t do it without special knowledge and understanding of how Bollinger Bands work. 

General information about Bollinger Bands

Bollinger Bands were developed by John Bollinger. He is a very famous technical analyst that first published data about it in 1987. However, Bollinger Bands are widely used now. This tendency is going to keep up for a long time. What are the main features of this technical tool? It includes 3 lines that are developed for determining how changeable the market is. This economic characteristic is called ‘volatility’ and means how price is changing at a specific moment.

Bollinger Bands: what should you know about this indicator?

Let’s explain what the main components of this indicator are:

  1. Moving Average. It is a popular tool that is widely used among both professionals and newbies. There can be different types. You are able to use every one of them according to the situation.
  2. D. Deviation Coefficient (DC). You can set this option before applying the tool.
  3. Standard Deviation. It is a statistical value that shows how volatile the financial asset is at a specific moment. 

You don’t need to form this indicator autonomously because this task is automated in most trading applications, both for smartphones, tablets, or computers. You don’t even need to understand how it works for making profitable orders. Just use it.

Look at the picture to have a full understanding, what the corridor is. 

Bollinger Bands: what should you know about this indicator?

You may try different options autonomously but understand that changing of the important settings affects how this indicator is able to respond to the smallest changes. 

You’d better choose the DC between 1 and 5. Selecting a bigger number isn’t recommended because the reason behind using this indicator disappears. Price won’t touch them or will break them too often.

Moving averages are great tools for demonstrating price change in dynamics. However, if it is based on closing prices, the efficiency of it becomes bigger. This option is checked by default, and you’d better not change it.

Bollinger Bands tool is great for working on each timeframe. At the same time, you should understand that the reliability of this tool for technical analysis is totally dependent on the timeframe you set. The more you decide to set, the better your results will be. 

What is Bollinger Bands strategy and How to read the indicator?

What is Bollinger Bands strategy? There are many methods of BB signals interpretations.

The first interpretation

When all the Bollinger Bands are moving from left to the right, without significant increase and decrease of the price, the market is in a flat, the collecting of a position occurs. You can trade without the midline, but you should do it only if the distance between lines isn’t very small and there is a possibility of a change in the direction of the price to the opposite side. Also, it is significant if you work in the direction that corresponds to the trend preceding this corridor. For instance, if the price was growing before a balance, after corridor formation, it is better to work only from a low band. The opposite statement is also possible. 

Bollinger Bands: what should you know about this indicator?

Exit from this balance will almost always be accompanied by an impulse (if not, then, most likely, the exit will not be true). We see it on the screenshot above.

With impulse, bands diverge and a part of the trend on the graph starts on the market. If there is an ascending trend, price will always be placed above the middle band. We can say vice versa for descending price changes.

Bollinger Bands: what should you know about this indicator?

It is better to open orders in the area of the  middle line. Most often it is an ending of a correction movement. The best point for fixing positions is Bollinger borders or when a price goes far beyond the line. These points are great for fixing profit. However, you mustn’t trade against the existing tendency. As soon as the price consolidates (1-3 bars) below the midline in an uptrend (higher in a downtrend), this is the first sign that the trend is ending, and we will soon have a new corridor (balance).

Advice. When you use this technical tool, don’t be guided by the high accuracy of the bounce off the lines. For instance, if the price was closed 2 ticks below the middle band, it isn’t a fixing below the line. Wait for 1-2 bars (or candles) to make sure that it is a real signal.

The second interpretation of how to use Bollinger Bands for profitable trading

One more interesting interpretation is the connection between Bollinger Bands and RSI. This strategy is called Bollinger-RSI. 

RSI is an indicator that shows an amplitude and a speed of price changes for a certain part of the time. 

BB is a typical example of trend indicators that show the tendency that is relevant for a certain period. RSI is an oscillator. It can predict tendencies and has two zones that are informative for traders: overbought and oversold.

Usually, oscillators don’t work when there is a trend on the market but they are great when price changes in a small corridor.

Let’s return to the BB + RSI strategy. A signal to purchase has 3 signs:

  1. RSI crosses level 30 from bottom to top (the indicator leaves the oversold zone).
  2. A price leaves a BB corridor to the bottom and breaks the low Band of BB from bottom to top (the indicator returns to the corridor). 
  3. We enter only after the closing of a bar or candle higher than the low Band. 

A signal to sell has 3 signs:

  1. RSI crosses 70 to the bottom. It is leaving the overbought zone. 
  2. A price leaves a BB corridor to the top and crosses the high Band of BB from top to bottom.
  3. We enter only after the closing of a bar or candle lower than the upper Band. 

If there is a market trend, signals will be forming for potential corrections that can be very short. After that, the market continues to move. That’s why you shouldn’t take into account only what indicators show you. Also, you need to understand which phase of the market is now. 

Methods of using Bollinger Bands indicator

Let’s describe the main methods of using the Bollinger Bands indicator.

Narrowing and expanding the range

If the range expands, the volatility becomes bigger. The opposite statement is also right. The longer a range is narrow, the stronger the impulse of the price after a trend starts.

This signal is the best if your timeframe is m5-m15. M5 is better than m15 or m1. Your task is to catch an impulse when the price is growing extremely. It is difficult because you never know if it is a true breaking or false.

High and low prices

It can say that the price is overbought or oversold if the market doesn’t have any trend. In these cases, you can expect price reversal. 

The minimal goal is a middle line, the maximum is an opposite line of BB.

Price rebound from the midline

If you choose a period of indicator correctly, you can turn a middle line into a dynamic resistance/support level. If we break this line and the prices consolidate beyond it, it means stopping or reversal of the trend.

Wrapping up

Bollinger Bands (BB) is a great financial instrument that is used in a lot of strategies. We described a little part of them for better understanding the trend.

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author

Carolyn Huntington is an economist, professional trader, and analyst. She made her first big deal in her student years with a profitable investment in Facebook stock. Now the total experience of her trade is 18 years. Over the years of trading, Carolyn has developed its own strategy that allows even those who have never traded on the stock exchange before to earn money. She also creates market forecasts and advises major shareholders, compiles investment portfolios, and teaches how to work with automated advisors.

telephone: 503-547-5192