bollinger bands

What are Bollinger Bands?

deltafx writer 4 September 2021

Bollinger bands are considered one of the most famous technical analysis tools in the trading world. They refer to the price channels or bands that indicate the volatility range of an asset on a chart. They are made of 3 main lines: the upper band, middle band and lower band. The middle band is actually a 20-period simple moving average (SMA). As you can see in the picture, the lower and upper bands are drawn around the simple moving average line. Standard deviations specify the distance between the upper and lower bands.

bollinger bands

Bollinger bands usually work based on 20-period ranges. These periods are customizable, and you can choose different hours or days based on your trading strategy and the information you need to know. However, the 20-period range is not something fixed, and traders can change it at their own discern.

How do Bollinger bands work?

When the distance between upper and lower bands decreases during a period of volatility, the possibility of seeing a sharp price movement in any direction will increase. This situation may also start a trend. However, sometimes before a trend begins, seeing a move in the opposite direction of the trend is possible. When the distance between the upper and lower band increases, volatility expands, and the current trend may terminate.

The price moves between the bands, and it may hit the upper or lower bands. Using such fluctuations, you can find the best opportunities to make a good profit. for example, when the price fell from the upper band and crosses the simple moving average, you can expect the price to fall further to the lower band.

Sometimes, the price can go further from a band or stick to it for a long time during strong trends. In such a situation, on divergence with a momentum oscillator, it is better to research more before deciding whether taking more profits is possible for you.

You can always expect to see a strong trend continuation when the prices go beyond the bands. But when the price goes back inside the band quickly, we understand that the trend is not powerful enough.

Why do traders use Bollinger bands?

They have a lot of advantages for traders. Bollinger bands can determine price patterns and trend strength and help us spot the best entry points in range-bound markets, especially in volatile markets. We recommend that you do not use this indicator alone because although it may seem very useful for traders, it is always better to use several indicators to achieve the best results. A combination of Bollinger bands and other indicators will give you a detailed view of the markets.

How to use Bollinger bands for our trades?

Traders use Bollinger bands in different ways based on their strategies and trading goals. You can use Bollinger bands for trading stocks, CFDs, options etc. some traders believe that lower and upper bands are always the price targets. Other traders start to buy when the price reaches the lower band and sell an asset when the price reaches the simple moving average. However, some traders prefer to sell when the price crosses the lower band and buy when it goes beyond the upper bands. So, everything depends on the traders’ strategy and goals. Here we talk about two famous strategies that they use:

Squeeze strategy

One of the simplest strategies for Bollinger bands is the “squeeze” strategy. It happens after the aggressive movements of the price when it is moving sideways in a consolidation. We can easily see it on a chart because the upper and lower bands get closer together during a consolidation. It shows that the fluctuations of an asset price are decreasing.

bollinger bands squeez

Usually, after consolidation, the price of an asset will move up or down, and it provides excellent opportunities for traders.

Overbought and oversold strategies

Many traders use the overbought and oversold strategy every day in their trades. This strategy has a close relation with Bollinger bands and works based on the mean reversion of prices. Based on the mean reversion theory, when the prices go significantly higher or lower than the average, they will finally change their direction and return to the mean price.

The Bollinger bands indicate prices that have deviated from the mean amount. So, when we see the prices have moved significantly from the average amount, we can use this strategy to open a position. We know the price is going toward the simple moving average in the middle of the band. So, by using such a prediction, we can make a good profit from the opened position. There is another situation when the price goes beyond the upper or lower bands. Here, the best thing to do is go short and wait for the asset price to go toward the simple moving average.

Conclusion

Bollinger bands are useful indicators of a trend in a market. They are very user friendly, and every trader can easily work with them on different charts. Bollinger bands are lagging indicators which means traders may not receive a signal until the price movement is underway. John Bollinger, who developed this indicator, believes that it must be combined with other indicators. So, it is best always to use a combination of indicators to predict the prices in the future.

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