How to use bollinger bands in trading?

Analytical methods of studying the volatility of a market are very useful for implementing effective trading strategies. One of the most reliable methods in this area is undoubtedly the Bollinger Bands. Here is a complete presentation of this technical indicator of choice and its use in financial speculation.  

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How to use bollinger bands in trading?

Presentation of the Bollinger Bands :

Bollinger Bands are a form of indicator created by John Bollinger that is used to analyze the level of volatility of an asset's price. Bollinger Bands compare this volatility to the price level over a defined period.

Bollinger bands are actually displayed as 3 separate bands:

  • The upper band represents the simple moving average plus x times the standard deviation
  • The middle band displays the simple moving average
  • The lower band is the simple moving average minus x times the standard deviation

Generally speaking, asset prices are supposed to move within the middle band, i.e. between the upper and lower bands. We can therefore say that the Bollinger bands adjust according to the volatility of the market.

Indeed, when volatility is low, the standard deviation is also low and the Bollinger bands are therefore closer together. Conversely, when volatility is high, these bands move further apart.

 

How to use Bollinger Bands in trading?

We have therefore accepted that Bollinger Bands are primarily used to assess the level of volatility in the price of an asset for a given period.  But they can also be used to detect other useful information, the main ones being

  • The strength of the trend: It is observed by the crossing of the Bollinger bands by the price of the asset. When the price crosses the upper band, there is a strong upward trend. On the contrary, when they cross the lower band, we have a strong bearish trend.
  • Support and resistance levels: When the market is not showing any particular strong trend, the Bollinger Bands can be used to indicate support and resistance levels as asset prices most often oscillate between the upper and lower bands.
  • A decrease in volatility: The convergence of the upper and lower bands represents a decrease in the volatility level of the asset price. We know that these periods of low volatility often herald a price boom.
  • The direction of the trend: The graphic figures of the double troughs or double tops make it possible to anticipate a reversal of the trend.  Clearly, when a double bottom forms at the upper band with a bottom in this band and another just below it, this indicates a bearish signal. Conversely, when two successive highs form, the first at the lower band and the other just above it, this is a good bullish signal.

The use of the indicator that expresses and compares the gap between the two Bollinger bands (upper and lower) is also interesting. When the latter tends to increase, it indicates that the gap between the two extreme bands compared to the simple moving average is increasing. This means that volatility is increasing. This indicates that the asset price is in a specific trend and that it is the right time to take a position. It is when the gap between these bands decreases that the trend disappears and volatility is lower.

 

When is the best time to take a position with the Bollinger Bands?

Want to use Bollinger Bands to determine the best time to take a position in the market? Here's how to do it.

First and foremost and in summary, it is time to take a buy position when you see a price in the upper area of the Bollinger Bands from a chart perspective. On the contrary, it is time to take a sell position when the price of your asset appears in the lower area of the Bollinger Bands.

Ultimately, the Bollinger Bands will not tell you the right time to take a position every time. You have to wait until the price is in the upper or lower part of these bands for your position to be taken at the right time, i.e. at the start of a strong trend. If you see the price of your asset in the neutral zone of these bands, there is no need to take a position if you are considering a trend strategy. However, you can trade during this period by adopting a very short term strategy and within the current trading range.

Bollinger Bands are therefore excellent indicators of market entry and exit points for medium and long term strategies but are not the preferred indicators if you are considering a short term strategy.

 

Trend trading with Bollinger Bands:

The best way to use the Bollinger Bands is to adopt a trend strategy. Indeed, trend traders will often prefer exits beyond the Bollinger Bands to take advantage of range breakouts and thus benefit from a new trend as soon as possible.

Here is our advice if you are using this technical indicator for the first time: The ideal is to wait for the closing of a bar on the other side of the bands, whether the trend is up or down, in order to take a position and benefit from the full amplitude of the movement observed and the resumption of high volatility.

Another way to trade trends with Bollinger Bands is to wait for a first wave of momentum visible through the bands before a correction in order to seize a more traditional trading opportunity with the test of the lower band if it is an uptrend and the upper band if it is a downtrend.

 

Range trading with Bollinger Bands:

Another frequently used strategy for trading with the Bollinger Bands indicator is the Range strategy. Here is how to apply it.

Here we will focus on the bounces that occur on the high and low bands as a signal. When the conditions for range trading are met, the investor can take advantage of these bounces with the Bollinger Bands to take profits in the middle and bottom of the range. Once the trader reaches the bottom of the range, he will take a reverse position until he reaches the middle and top of the range to take profits.

Finally, it should be noted here that in a range market, the upper and lower bands of the Bollinger Bands are to be considered as technical resistance and support on which the range evolves.

 

Some additional tips on how to use Bollinger Bands in your trades:

To finish this article, here are some very useful tips if you want to use the Bollinger Bands indicator in your online trading.

First of all, let's remember that Bollinger Bands are indicators that give a relative definition of the volatility of a security.  Since this volatility as well as the notion of trend are already introduced in the construction of the bands, we will not use them in order to confirm a price.

Bollinger bands are primarily trend indicators. Therefore, it is not useful to use other indicators in this class at the same time. Instead, you should use other types of indicators such as volume or volatility indicators which are more complementary.

Remember also that the price of an asset can easily go above the upper band or below the lower band. When a candle closes outside of these Bollinger Bands, this pattern can be interpreted as a continuation of the trend and not a reversal.

Note also that the average given by the Bollinger Bands is not the one you should favour if you want to trade trend changes but rather to follow a medium or long term trend.

72% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. This is an advert for trading CFDs on Plus500