.png)
Bollinger Bands
What is Bollinger Bands[BB]?
Bollinger Bands, developed by John Bollinger in the 1980s, is widely used technical analysis tool in financial markets. They consist of a simple moving average (SMA) in the middle, and volatility bands placed above and below a moving average.
The bands automatically widen when volatility increases and contract when volatility decreases. The bands provide a visual representation of price volatility and are used to identify potential price reversals, overbought or oversold conditions, and the potential beginning or continuation of trends.
How its calculated:
Middle Band = 20 period Simple moving average (SMA)
The upper/lower band is calculated by adding/subtracting a specified number of standard deviations (typically 2) to the middle band. Standard deviation is a statistical measure of price volatility.
Upper Band = 20 period SMA + (20 period standard deviation of price X 2)
Lower Band = 20 period SMA + (20 period standard deviation of price X 2)
The resulting Bollinger Bands form a channel around the moving average, with the width of the channel determined by the asset's volatility.
Note: The standard deviation tells us how much the numbers in a data set vary from the average. A higher standard deviation indicates more variability or spread in the data, while a lower standard deviation suggests the numbers are closer to the average.
Interpretation of Bollinger Bands:
So, when the stock's price is going up or down a lot, the bands will be wider, and when the price is not changing much, the bands will be closer together. Many times, these bands act a boundary for price. These bands help us in a few ways. First, they can tell us if the stock is becoming too expensive or too cheap. When the price reaches the upper boundary, it might mean the stock is getting too expensive, and when it reaches the lower boundary, it might mean it's getting too cheap.
Second, they can help us see if the price is going to change direction. If the price reaches the upper boundary and starts coming down, it could mean that it will go down even more. And if it reaches the lower boundary and starts going up, it could mean it will go up even more. But this is not the case always.
Bollinger Bands Secrets and various ways to use BB:
1. Bollinger Band squeeze:
Sometimes, Bollinger Bands become narrow, indicating low volatility in the market. This is known as a Bollinger Bands squeeze. It's like squeezing
a spring before it bursts open. Traders use this pattern to anticipate a big price move. When the bands squeeze, it suggests that the market is in a
period of consolidation or indecision. Traders can wait for a breakout.
- when price breaks above the upper band its bullish signal or
- when price breakout below the lower band, its bearish signal.
Traders can enter a trade in the direction of the breakout, anticipating a significant price movement.
2. Middle Band as a Direction Indicator:
The middle band of the Bollinger Bands, which represents the average price, can act as a directional indicator.
- When the price is above the middle band, it suggests an uptrend, and traders may consider bullish trades.
- Conversely, when the price is below the middle band, it indicates a downtrend, and traders may consider bearish trades.
Traders can also observe the slope of the middle band to gauge the strength of the trend.
- An upward-sloping middle band indicates a strong uptrend,
- while a downward slope suggests a strong downtrend.
3. Bands as support and Resistance
Bollinger Bands can be used as a tool to identify potential support and resistance levels Determine whether the market is in an uptrend,
downtrend, or range-bound movement. This will provide context for using Bollinger Bands effectively. Watch how the price interacts with the
Bollinger Bands.
·In up-trending markets middle band acts as a strong support and in down-trending markets middle band act as strong resistance. so in uptrending markets any reversal from middle band you can use for taking bullish trade.
In sideways markets, When the price approaches the upper band, it may encounter resistance, signalling a potential reversal or a temporary halt in the upward movement. And when the price nears the lower band, it may find support, indicating a possible bounce or temporary pause in the downward movement.
It's important to use additional indicators or techniques to confirm potential support or resistance levels suggested by Bollinger Bands. This can include candlestick patterns, trendlines, or other technical analysis tools. Confirmation helps increase the reliability of support and resistance levels
identified by Bollinger Bands.
4. Riding the Bollinger Band
Riding the band strategy involves identifying strong trending markets and trading in the direction of the trend. When the price consistently stays
near the upper band and upper band is expanding it suggests a strong uptrend, and traders can consider buying or holding their positions.
Similarly, when the price consistently hugs the lower band, and lower band expanding it indicates a strong downtrend, and traders can consider
selling or staying short.
Now you will find this in contradiction with logic that bands act as support and resistance, then how to play Bollinger band breakouts. Normally,
66% of the time prices remain with in the band but 33% of the they trade outside the band. However, it's crucial to confirm the trend with other
technical indicators or analysis tools to avoid false signals. Trends can change, so it's important to monitor the market closely and adjust trading
strategies accordingly. One way trade uptrend is, when strong trend in confirmed say on daily charts(price breaks outside band), we can use some
indicator on 15min or 30min chart and trade on that signals, in direction of larger timeframe only.
5. Using Bands as target and stop loss
Bollinger Bands can also be used to set targets for price movements. The upper band and lower band can serve as potential targets for profit booking.
In reversal trade from lower band middle can be first target and upper band can be second target.
For any trade taken above middle band. SL can be close below middle band.
6. Multi-timeframe Bollinger bands
Using Bollinger Bands on multiple time frames on the same chart can provide valuable insights into price dynamics and trends across different
time horizons.
When the Bollinger Bands on different time frames align, it indicates a higher probability of a strong trend or significant price movement. Select
two timeframes say Daily and weekly. Apply Bollinger Bands to each time frame on the same chart. For example, if the price is touching or crossing
the upper Bollinger Band on both the daily and weekly charts, it suggests a strong bullish trend and vice versa.
Another way, we can use select one timeframe (say daily) for identifying direction and second timeframe (say hourly) for getting entry signals.
For example, if the price is above middle band on daily chart and its touching lower band on hourly chart, we can use any reversal signal from this level as entry for bullish trade.
7. Using Bollinger bands with other indicators
a. Bollinger Bands with Fibonacci Retracement
Traders can use Bollinger Bands in conjunction with Fibonacci retracement levels to identify potential support and resistance levels. When the price approaches a Fibonacci retracement level and coincides with the upper or lower band, it could signal apotential reversal.
b. Bollinger Bands with Stochastic Oscillator:
The Stochastic Oscillator is an indicator used to identify overbought and oversold conditions. When the price touches or crosses the upper Bollinger Band and the Stochastic Oscillator is in the overbought zone (typically above 80), it suggests a potential reversal or downward movement.
When the price touches or crosses the lower Bollinger Band and the Stochastic Oscillator is in the oversold zone (typically below 20), it suggests a potential upward movement. Traders can use these signals in conjunction with Bollinger Bands to confirm potential entry or exit points.
Conclusion
Bollinger Bands is a versatile tool that provides valuable insights into price volatility, trend reversals, and overbought or oversold conditions. Traders can utilize various strategies, such as breakouts, reversals, and riding trends, to capitalize the information provided by these bands. However, it is essential to remember that Bollinger Bands should not be used as standalone indicators, but in conjunction with other technical analysis tools and indicators to increase the probability of successful trades.
By understanding the calculation of Bollinger Bands, exploring different trading techniques, and combining them with other indicators, traders can make informed decisions and improve their trading outcomes. As with any trading tool or strategy, it is crucial to practice risk management and conduct thorough analysis before executing trades based on Bollinger Bands or any other technical analysis approach.
Disclaimer:
1. Objective of this documents is share knowledge on Indicator and not the strategy.
2. Before using for trading please understand character of indicator and precautions to be taken while using.
3. A great indicator is useless without proper discipline and even mediocre indicator can do the trick with strong discipline.
4. Observe 100s of historical charts using this indicator or in combination of other indicators and see how it works. Then try to form the rules for entry / exit and stop loss.
