Bollinger Bands:
Bollinger Bands is a very commonly used technical analysis indicators which is quite useful in ranging markets and also to indicates possible breakouts from the ongoing sideways movements. Let's study the concepts behind Bollinger Bands and also possible trading strategies with this indicator.
Bollinger Bands were developed by John Bollinger.
Bollinger Bands are a pair of bands (lines) representing the upper and lower trading ranges.
When we apply Bollinger Bands to the trading chart we would see 3 bands (lines):
1) Upper Band
2) Lower Band
3) Mid Band
chart 1:
As seen in the above candle stick chart for EUR/USD in Fig 1, the Bollinger Bands are three blue dotted lines which seem like flow of a stream.
It seems that when the price goes down and touches the lower band, it goes up and when it goes up and touch the upper band then it goes down. Well, this is how the Bollinger Bands are used to predict when to enter and when to exit i.e. when to buy and when to sell or short sell. But please note that this buying/ selling trading signals are only good when the price action is in range (sideways) and without up or down trend.
Bollinger Bands are good when market in range (neither bullish nor bearish) but not when its trending market (uptrend i.e. bullish or downtrend i.e. bearish)
Why? Well, if we see the chart in Fig 2 below, it is clear as to what would have happened if entry/exits were made during range (points A,B,C,D) and what if entry/exits were made during the trend (point X,Y)
Chart 2:
1) If we had short sold the pair at A (when price touched Upper band) then we could have made profits by covering the trade when the the lower band was touched at B.
2) If we had bought at B (when price touched Lower Band) then we could have made profits by covering the trade when the it touched the Upper Band at C.
------ and so on….
If we short sold EUR/USD at X (when price touched Upper band) and waited for it to touch the lower Band to take profits, we would be in loss as it never went down to touch the lower band. Same with point Y and so on.
1) When the market is moving in range (sideways movement): Buy when the price touches the lower band or goes outside of the bottom band. Sell at the moving average i.e. middle band.
2) When the market is moving in range (sideways movement): Short sell when the price touches the upper band or goes outside of the upper band. Sell at the moving average i.e. middle band.
1) When the market is in range (sideways movement): Buy when the price touches the lower band or goes outside of the bottom band. Sell when it touches the opposing band i.e. upper band.
2) When the market is in range (sideways movement): Short sell when the price touches the upper band or goes outside of the upper band. Sell when it touches the opposing band i.e. lower Bollinger band.
Middle Band = Moving average for the periods selected i.e. if the selected period is 20 then moving average for 14 periods.
Upper Band = Middle band + 2 standard deviations
Lower Band = Middle band – 2 standard deviations.
The quite preferred setting for the Bollinger Bands indicator is 14 periods, which means if we were to calculate on a daily chart we would measure 14 days, and in the case of an hourly chart, we would measure 14 hours. The default setting of 14 is common to several popular indicators, such as Relative Strength Index (RSI) and Average True Range (ATR).
We explained Bollinger Bands in the for technical analysis in the context of Forex Trading but the same stands good for stock trading or any commodity trading.
Check some Bollinger Band Strategies
Check some Bollinger Bands videos |
