Traders use many technical indicators to get help in their trading journey with the intention to avoid potential losses and gain incredible returns on their investment. Bollinger bands help traders get sufficient knowledge about the right time to enter the market and open their position.
Trading is all about identifying the correct entry and exit points, monitoring your position, taking profits, and closing the position. Bollinger bands tool is now widely used by traders who trade in different asset classes. They do not only depend on one technical indicator for technical analysis. It can include many such tools to increase the amount of profit they want to gain without paying attention to risks.
This tool can be used in each trading style, whether scalping, swing trading or long-term investments.
Learning price patterns like the candlestick charts and the Fibonacci retracement is only part of price action trading. We sometimes neglect one of the most important aspects of price action that is volatility. It’s just as crucial to know how much the market moves to know which way it goes. Bollinger Bands are a powerful technique for incorporating volatility into our analyses.
What is a Bollinger Band?
Bollinger band is a tool that can be used in technical analysis before investing in any asset. John Bollinger developed Bollinger Bands as a specialised trading technique in the early 1980s. The bands are price envelopes drawn at a standard deviation level above and below the simple moving average. The tool can be used in stocks, Forex, commodities, equities and futures, among other financial markets.
John Bollinger’s technical analysis tool aids traders in gaining a comprehensive understanding of current or upcoming trends, as well as overbought and oversold signals. Bollinger Bands are determined at a certain number of standard deviations above and below the moving average, causing them to broaden in volatile markets and contract in stable markets. Bollinger Bands can be employed in a variety of time frames, including hourly, daily, weekly, and monthly.
A simple moving average is a standard trend-following indicator that measures the overall strength and direction by tracking the mean closing price of a stock or commodity over time. Bollinger band is made up of three parts which are simple moving average, an upper band, and a lower band.
Moving averages are used in almost all trading strategies as both fundamental trends for indicators and as building blocks for trend confirming tools such as MACD (Moving Average Convergence and Divergence).
Bollinger bands trading strategies
The traders use so many strategies to implement Bollinger bands trading successfully. They tend to sell their securities before a reversal happens during an advance. Traders tend to buy equities during a slump as selling activity among other sellers increases.
Here are the best Bollinger band trading strategies
Bollinger bands for trends
If the uptrend is strong enough, it will regularly approach the top band, indicating that the stock will rise in value. Similarly, it prompts a trader’s thoughts to make a purchase decision since they believe it is a fantastic opportunity. Because costs can fluctuate, it’s essential to keep this in mind.
Bollinger bands can assist a trader in determining an asset’s rising prospects. This is because Bollinger bands characterise an asset thoroughly, even if it potentially loses strength or reversing. For example, if prices fall into the lower band during an uptrend, the stock loses its strength and serves as a warning indicator for traders. But if prices pull back but stay within the middle band before moving forward to the top band, the asset shows a lot of strength.
Bollinger Bands are commonly used by traders to assess overbought and oversold zones, confirm price and study divergences, and project price goals. The wider the bands, the more volatility. The lower the volatility, the smaller the bands.
Prices can swing between the bottom band and the simple moving average during a strong downturn. Conversely, there is a substantial price movement between the upper band and the simple moving average in a strong rally. In any case, price crossing over the moving average usually indicates a trend reversal.
Traders mostly use Bollinger Bands to obtain a sense of assets in downtrends. For example, it aids them in determining the assets’ dropping state, particularly when the trend is reversing from the upswing. Prices are likely to remain constant beside the bottom band during a strong downturn. It increases the chances of selling activities.
But prices are likely to lose momentum if they do not move along or contact the lower band. Traders avoid trading during downtrends, yet they find it to be the finest buying opportunity. Traders look for signals of downtrend strength in such instances, especially when the price pulls back or stays below the middle band. If the prices break above the top band, it could signify a trend reversal.
Bollinger bands squeezes
The squeeze is underlined by a dramatic decline in Bollinger’s Band Width indicator when bands contract in a narrow neck. The squeeze causes the bands to tighten in a more parallel pattern. The squeeze signal is also regarded as a low volatility phase and a hint that higher volatility is on the way in the near future, increasing traders’ trading chances. But when the bands widen, this suggests a drop in volatility, and traders will begin to quit the trade in more significant numbers.
Other signs must be consulted in order to establish the breakout’s direction. Momentum indicators such as the relative strength index (RSI) and Stochastic Oscillators can assist determine whether the divergence will be positive or negative. The squeeze is typically assumed to foreshadow a breakout since it represents a significant and protracted period of low volatility.
A positive divergence is a bullish signal, whereas a negative divergence is a bearish signal in the context of these indicators. To be safe, use a range of instruments and wait for strong trend confirmation before deciding on an investment strategy. Traders see the squeeze as a result of prior volatility as well as a foreshadowing of future volatility.
How to calculate Bollinger bands?
Bollinger bands can be calculated by keeping three things in mind, which are upper band, middle line and lower band. By following this concept, you can easily calculate the Bollinger bands and identify the required parameters for trading. These parameters will help you build a robust investment portfolio, enabling you to gain higher returns in your trading career. You also want to eliminate the potential losses regarding your investments.
To trade in every possible asset class, there are specific strategies you need to follow. Some of them require your attention to cut off the losses and prevent to occur them in future. And others need your attention to take small profits to cover up potential losses. To successfully implement these strategies, you may want to use Bollinger bands trading, and you should know how to calculate the Bollinger bands.
Formula to calculate Bollinger bands
So coming to the elements, which are the upper, middle and lower band. The upper band is plotted above the middle line of the simple moving average (SMA) of the closing prices. The upper band of the Bollinger band is the product of standard deviation and input factor above the moving average.
On the other hand, the lower band is plotted below the middle of the simple moving average of the closing prices. Thus, the lower one is the product of standard deviation and input factor below the moving average.
The middle band represents a 20 period moving average.
You may wonder what the role of standard deviation here is. Standard deviation is the difference between the values of the price and the mean value. It is the statistical measure required for the Bollinger bands to perform the technical analysis. It is the same as volatility and gives you a clear idea of how much the numbers varying from an average value.
Here is the formula to calculate both upper and lower Bollinger bands
Upper Bollinger band = MA(TP,n)+m∗σ[TP,n]
Lower Bollinger band = MA(TP,n)−m∗σ[TP,n]
Where, MA = Moving average, TP = Typical price = (High+Low+Close)/3,
n = Number of days, m = Number of standard deviation.
σ[TP,n] = standard deviation of n periods of typical price.
Limitations of Bollinger bands
- The Bollinger band is just one indicator. You have to use it with other irrelevant indicators to get the results. Instead of providing one whole trading setup, it requires mixing it up with other tools also. They are not a standalone trading system.
- They will give you information only about the volatility of the price, which can be a massive disadvantage for traders. Bollinger bands have flaws that may restrict you to identify necessary trading signals at the right time.
- You need to keep changing the settings of the indicator even at the times when you are trading the same asset. It can confuse or irritate the trader, and in case you forget to change the settings, you may have to pay a heavy price for it. The setting varies according to the market from time to time.
- Sometimes, you may face difficulties in spotting the potential market reversals with Bollinger bands. You need to be aware of such things whenever possible. Plus, it is just a tool, not a whole indicator which means that you cannot completely depend upon it. A standalone indicator can help in so many things to adapt to the market conditions and trade accordingly.
Get your expectations moderate if you are totally dependent on it, but the good part is that it can give you excellent results when you use this tool with other indicators. In that case, Bollinger bands can be a good guardian for your trading.
- The use of 2 standard deviations and a 20-day simple moving average may not help you. These parameters only work for traders in only particular conditions. You may get irritated when the results are not in place, so please ensure to follow a specific strategy and stick to it.
- Even after the tool settings are fixed and installed correctly, it can give false trading signals.
Bollinger bands are one of the most important indicators to predict the dynamic support and resistance level also. Traders use this indicator for various purposes in trading. But you should know where it can be helpful for you according to the asset you are trading and other factors like market conditions. You need a well-regulated broker to get access to tools like Bollinger bands. 101investing is one of the reputed brokers that provides a wide range of analytical tools, including Bollinger bands.
Bollinger bands help you to be stable at the correct position in the market, and you can quickly monitor the right trends while trading.