Bollinger Bands are on the best and most popular trading indicators of all-time. It is very easy to apply, and it also has good accuracy. Bollinger Bands use the primary calculation method of standard deviation. Below we're going to provide you with some of the best Bollinger Bands trading strategies that you can apply on your trading journey to find winning trades.
02 October 2020 | AtoZ Markets - In this article we're going to provide you with everything you need to know about Bollinger Bands. It will give you ideas such as, what are Bollinger Bands? How does it work? What are the Bollinger Bands strategies that you can apply to become profitable?
What Are the Bollinger Bands?
John Bollinger was the creator of the Bollinger Bands. In the 1980s, he invented this method to understand the volatility of any financial instrument or commodity. Moreover, financial traders employ these charts as a methodical tool to tell trading judgments, control automated trading systems, and as an element of technical analysis. Furthermore, Bollinger Bands show a graphical band (the wrap maximum and minimum of moving averages, similar to Keltner or Donchian channels), and volatility (exposed by the beam of the cover) in one two-dimensional chart.
How do Bollinger Bands work?
Two inputs parameters chosen to separate by the user rule, to see how the chart reduces the known historical price data. It also allows the user to vary the reply of the chart, to the magnitude and frequency of the price changes. With, Bollinger Bands uses a statistical calculation known as standard deviation. To establish where a band of likely support or resistance level might lie. This is an earmarked utilization of a broader idea knew as a volatility channel.
A volatility channel plots lines above and below a central measure of price. According to volatility or non-volatility of a market, these lines also known as envelops or bands, widen or contract. Bollinger Bands calculate market volatility and provide lots of useful knowledge, like -
- Trend continuation or reversal
- Periods of upcoming great volatility breakouts
- Periods of markets consolidation
- Possible market tops or bottoms, and possible price target
Bollinger Bands contains three bands. It rotates around a centred simple moving average (SMA). It has the default value of 20, of which 85% of the time. The price held within the following boundaries:
- Upper Band - SMA (minus two standard deviations)
- Lower Band - SMA (plus two standard deviations )
Illustration of Bollinger Band
Bollinger Bands most basic concept is that the channels illustrate a measure of high and low. Let's know the three key points of Bollinger Bands:
- The upper band shows a level that is statistically high or overvalues
- The lower band shows a level that is statistically low or undervalues
- The Bollinger Bandwidth relations to the volatility of the market
That's why standard deviation increase as the price ranges broaden and fall in small trading ranges.
So:
- Bollinger Bands widen when the market volatility increases.
- Bollinger Bands narrow when the market volatility decreases.
Trading Strategies of Bollinger Bands
Below we're going to show you Bollinger Bands 3 most profitable strategies that can help you to become a profitable trader. The strategies are very simple to use, but you need some practices to become master on it.
Bollinger Bands Scalping Strategy
In this Bollinger Bands scalping strategy, we will use 15 minutes chart for scalp the market.
3 Indicators which applied on the chart:
- Bollinger Bands (20,2)
- Stochastic Oscillator (7,10,3)
- 2 line MACD (12,26,9)
BUY Trade
To buy trade, you have to look for the price come to the middle band and bounced higher. After that, if the price breaks above the upper band resistance and closes above it, then enter a buy trade on the next candle. You also have to see that the Stochastic Oscillator and MACD lines are moving upward or cross each other upside. Your stop loss should be below the bullish close candle, which broke the upper band and take a profit level according to the 1:2 ratio.
SELL Trade
Sell trade is as same as a buy trade concept. You have to look for the price come to the middle band and push lower. After that, if the price breaks below the lower band support and closes below it, then enter a sell trade on the next candle. You also have to see that the Stochastic Oscillator and MACD lines are moving downward or crossing each other downside. Your stop loss should be below the bearish close candle, which broke the lower band and take a profit level according to the 1:2 ratio.
Bollinger Bands Double Bottoms Strategy
Double bottoms Bollinger Bands strategy is easy to use, but very effective. John Bollinger himself said, "Bollinger Bands can be used in pattern recognition to define/clarify pure price patterns such as “M” tops and “W” bottoms, momentum shifts, etc.”
The first bottom of this type of structure supervises volume and pullback that closes outer of the lower Bollinger Band. Moreover, these types of structures called the "automatic rally". The price tries to retest the recent lows that have been set to challenge the force of the buying pressure that comes in the bottom after rally starts.
Many traders look for these types of retest candle to strike inside the lower band. It indicates that the hand is changing from the sellers to buyers. Besides, you will see the volume drop off dramatically.
Bollinger Bands Squeeze Strategy
This squeeze strategy uses to measure the start of an upcoming squeeze. John Bollinger invented this indicator, known as the bandwidth. This bandwidth formula is simple (Upper Bollinger Band Value - Lower Bollinger Band Value) or Middle Bollinger Band value (SMA).
The main idea is very simple. When the indicator comes at the lowest level in six months; there is a high chance of the volatility to increase. This type of squeezing action of the Bollinger Bands indicator can be a result of an upcoming big move. Besides that, you can also use an additional indicator such as volume expanding or the accumulation distribution. These other indicators can add some confluence to this strategy. You need to be very careful when you trade Bollinger Bands squeeze because of these setups can head-fake the best of us.
Let's check how to use Bollinger Bands squeeze to gain the advantage. Below is a 15-minute chart of USDCAD from March 5, 2020. Notice that the band was extremely tight.
Many traders can create a mindset to short in this market by thinking that the band will carry the price much lower. Others can wait for confirmation with this belief. Here are some ways to handle this sort of setup:
- Wait for the candle to come back inside the bands.
- Make a confirmation that there are a few inside bars that didn't break the low of the first candle.
- Sell on the break of the low of the first candle.
Based on these three requirements, you can think these types of market scenarios are very rare. But when this happens, it brings great opportunities. The below chart will illustrate this approach.
You can also implement this method on the buy trade as well.
Conclusion
Bollinger Bands have a lot of methods, but these are the great methods for trading with bands. By using the Bollinger Bands, you can become used to thinking about volatility. We hope that you enjoyed reading this article. These strategies need to practice many times; when you become a master on it, you can see that the magic behind these strategies.
Think we missed something? Let us know in the comment section below.