Introduction
Bollinger Bands are referred to as powerful technical analysis tools in trading. It helps traders and investors to measure market volatility, identify trends, and produce signals. Bollinger Bands was created by John Bollinger in 1980 and used to analyze different financial tools, such as commodities, currencies, and stocks. The Bollinger Bands also helps to encapsulate the price movement, by creating highs and lows. The Bollinger Bands rely on moving averages based on time frames that are beneficial for traders.
These bands are easily available on trading platforms and help you to increase gains. In this article, we will tell you about the basics of Bollinger Bands, advanced Bollinger Bands strategies, technical tools to use with these bands, and practical tips to increase your trading success.
Understanding Bollinger Bands
Bollinger Bands are the technical analysis tools that give you a visual representation of prevailing trends and market volatility. Bollinger bands help to indicate the level of market volatility and trading opportunities. It consists the three lines, the central line is referred to as simple moving averages ( SMA). It consists of 20 periods, whereas the upper and lower lines are standard deviations away from SMA. The Bollinger Bands arrangements create band-like structures and expand and contract based on market volatility.
Components of Bollinger Bands
Bollinger Bands can be used to evaluate how strong the asset is rising. Here are the 3 important components of Bollinger Bands
Middle Band
Middle Band is the 20-day simple moving average ( SMA). This Band works as a baseline for lower and upper bands. It marks the medium-term trend of trade.
Upper Band
The Upper Band is set two standard deviations above the middle SMA. It expands with market volatility and contracts with decreased volatility. It works as a resistance level in an uptrend.
Lower Band
The lower Band is set two deviations under Middle SMA. It narrows and widens in sync with the upper Band. The lower Band works as a support level in a downtrend.
Let us look at the table below to shortly understand the Bollinger Bands components.
| Component | Description |
| Upper Band | This Band is calculated by add two standard deviations to the simple moving average (SMA) of the price. It marks the potential overbought conditions. |
| Lower Band | This Band is calculated by subtracting two standard deviations from the SMA. It marks potentially oversold conditions. |
| Middle Band (SMA) | The middle Band is the simple moving average (SMA) of the price over a specified period (usually 20 periods). It works as a baseline for the upper and lower bands. |
Market Conditions Indicated by Bollinger Bands
Bollinger Bands is a famous technical analysis tool used by traders. Here are the different market conditions indicated by Bollinger Bands
Trending Markets
Prices move along the upper or lower Band in the trending market. When prices touch the upper Band, then it shows a strong uptrend. When the prices touch the lower Band, they show a strong downtrend.
Ranging Markets
In ranging markets, prices oscillate between lower and upper bands. It provides gravity towards the middle Band. It indicates the lack of directional movements and gives round-bound trading strategies opportunities to traders.
Setting Up Bollinger Bands in MT4
Here is the step-by-step guide you should follow to set up the Bollinger Bands in MT4
Open MT4:
First, you have to launch the MT4 platform and choose the chart where you want to apply bands.
Access indicators:
Tap on the “Insert” option at the top of the platform.
Choose Bollinger Bands:
Now, move to the “Indicators” option, go to the “Trend” section, and choose “Bollinger Bands.”
Customize settings:
A dialog box opens on your screen. You have to make some adjustments here. You have to set several periods (usually 20) for moving averages. You have to adjust the standard deviation (close to 2). You have to choose the price type.
Color & Style:
Next, you have to customize line style and color as per your clarity and visibility.
Apply:
Now, tap on the Ok option to apply Bollinger Bands to the trading chart.
Analyze:
Now, you have to review the Bollinger Bands and how they interact with price action. You have to determine whether it works according to your trading strategy or not.
Advanced Bollinger Bands Trading Strategies
There are various techniques traders follow while using Bollinger Bands. It is important to keep in mind that no indicators will used in isolation, so combining bands with other tools helps you to get the most out of your trading strategy. Here, we tell you different Advanced Bollinger Bands Trading Strategies.
Bollinger Band Squeeze
Bollinger Bands Squeeze is an advanced Bollinger Band approach that refers to a trading level that is getting smaller and shows a breakout is set to happen.
It takes place when the price moves rapidly and then abruptly begins to move averages in a close turn. When an asset’s rate is consolidating, a trader can see it in the chart because the lows and higher bars are becoming closer collectively. It shows a reduction in the asset’s volatility.
Following a duration pattern, prices generally circulate more extensively in both directions, preferably in high amounts. But keep in mind that this is just based on looking at historical results, so there’s no warranty that future returns can be worthwhile.
A breakout’s increasing volume indicates that traders are trading that the price will keep moving in the breakout course. The traders either sell or buy the asset whilst the price breaks by a lower or upper Band. Traditionally, a stop-loss order is located at the side of the breakout, which is contrary to the pattern.
Keep in mind that a general stop-loss order won’t prevent slippage. Traders can gather a guaranteed stop-loss for a price, which prevents slippage.
Double Bollinger Bands Strategy
Traders who use this Bollinger Bands trading approach upload two sets of price channels to their price chart. The first one is ready to default parameters: period of 20 and deviations of (BB2, or the outer BB). The second Bollinger Bands are set to a period of 20, but deviations of 1 (BB1, or the internal BB).
The location among BB1 and BB2 top bounds would be used as the Buy Zone, while the region among BB1 and BB2 lower bounds could be considered a Sell Zone. The places among higher and decreased BB1 bounds are used because of the Neutral Zone.
Traders who use DBB can either trade breakouts or observe the trend. They would be careful for a strong look into the Buy Zone or Sell Zone, and open a long or short role for this reason.
Trend Reversal Strategy with Bollinger Bands:
The Bollinger Reversal method aims to become aware of potential market reversals by the use of the Bollinger Bands along with other technical indicators. Traders can look for divergence between the price and the Bollinger Bands, wherein the price makes a better high or a low. However, the bands do not confirm the flow. This indicates a weakening trend and a probable reversal. Traders can then enter a trade in the opposite course as soon as the reversal is shown by different signs, including the Stochastic Oscillator or the Moving Average Convergence Divergence (MACD).
Bollinger Bands with RSI or Stochastic Oscillator:
Oscillators, including the Relative Strength Index (RSI) or the Stochastic Oscillator, can be used along with Bollinger Bands to verify trading signals. When the price is near the higher Band, and the oscillator is in an overbought state, it can be a signal to sell. Conversely, whilst the rate is close to the lower Band and the oscillator is in an oversold state, it can be a signal to buy. This approach allows traders to keep away from false signals and will increase the chance of successful trades.
Risk Management Techniques
Bollinger Bands gives you valuable insights, but it does not always guarantee profits. You have to follow risk management techniques to reduce the trading risks and make it more profitable.
Stop Loss orders
You have to set stop loss orders always to reduce losses. You have to place a stop loss just outside the Bollinger Bands when it exceeds the trade.
Position sizing
It is suggested that you determine the position size based on the risk level and account balance you want to take. Do not take risks more than the percentage of your account. Do not put whole money on a single trade.
Combining Bollinger Bands with Other Technical Tools
Traders are suggested to combine Bollinger Bands with other technical tools. It helps them to get valuable insights into market dynamics and improve their trading decisions.
Fibonacci Retracement Levels:
You have to combine the Bollinger Bands with the Fibonacci retracement level to improve your trading decisions. When the price movement occurs, you have to apply for the Fibonacci retracement levels to determine support and resistance levels. Once you plot the levels, it will analyzed with Bollinger Bands. For example, when the price retraces to Fibonacci levels, you have to look for convergence with bands.
If the price reaches 61.8% retracement levels and touches the lower Bollinger Bands, then it shows strong support levels and suggests a buying opportunity. On the other hand, if the price reaches Fibonacci resistance levels and touches upper Bollinger bands, then it shows impending reversal and shows you a selling opportunity.
This combination of Bollinger Bands with Fibonacci levels allows traders to evaluate entry and exit points. It improves trade accuracy and gives you confirmation about market behavior
Moving Averages:
Using Bollinger Bands with moving averages is suggested because it confirms your trends. If you combine it with 20 period moving averages, then it forms middle band settings. It allows traders to look at price crossing over moving averages as trend confirmation. Here are the signals shown by this combination
- Crossovers: Bullish signals arise when the price moves towards moving averages. Bearish signals occur when the price drops below.
- Confirmation: The Bollinger Bands helps traders to confirm the moving average crossover strength
Price Action Analysis
Bollinger Bands is useful for traders, but it is suggested that traders combine additional tools with it to make effective trading. Using a price action strategy in this case is helpful for you. This strategy has two main signals, so you have to keep this thing in mind. The price reaches one of the envelope borders. A price action analysis is triggered, and there is a morning star candlestick pattern in it.
Advantages and Limitations of Using Bollinger Bands
Bollinger Bands have some advantages and limitations, so you have to be aware of both sides. Let us tell you Bollinger Band’s benefits and drawbacks in detail given below.
Advantages
The importance of Bollinger Bands in the world of technical analysis and trading cannot be overstated. Here are its advantages
Volatility Measurement
Bollinger Bands provides a dynamic way to evaluate market volatility. The width of the bands expands and contracts in reaction to price volatility. Wider bands indicate better volatility, whilst narrower bands show reduced volatility. If the bands are narrow, it shows that the market is experiencing low volatility. If the bands are wide, it shows that the market is experiencing high volatility. Traders can use this information to adjust their strategies for this reason, consisting of tightening stop-loss orders for the duration of high volatility or getting into positions in the course of durations of low volatility.
Trend Identification
Bollinger Bands assist traders in identifying the course and strength of traits. When prices continuously experience along the upper Band, it indicates a strong uptrend, whereas prices go under the Band, it shows a strong downtrend. This data helps traders to align their positions with winning market traits.
Overbought and Oversold Conditions
Bollinger Bands can sign overbought and oversold conditions in the market. When the price touches or breaches the top Band, it can imply that an asset is overbought and due for a correction. Conversely, prices touching or dipping under the lower Band can also show oversold conditions and a potential rebound. Traders frequently use these indicators to make entry or exit points.
Reversal Indicators
Bollinger Bands can assist in identifying potential reversal factors in the market when costs flow to the outer bands, after which the opposite path can signal a reversal in the cutting-edge trend. This is particularly useful for swing traders and traders looking to capitalize on trend modifications.
Risk Management
Bollinger Bands provide risk management benefits by providing a visible representation of price volatility. Traders can modify their position sizes and stop-loss levels based on the width of the bands, helping them control risk extra efficiently.
Confirmation Tool
Bollinger Bands can be used alongside other technical signs to confirm trading signals. When more than one signs align, it can grow the self-belief in a particular trade setup.
Limitations
Below are a few limitations of Bollinger Bands.
Not Predictive of Future Prices
Bollinger Bands are based on old price information and provide data about beyond volatility and price levels. They do not predict future costs with reality, and trading decisions are subject to market risks.
False Signals
Bollinger Bands can produce false signals, mainly in uneven or sideways markets. Traders should work with caution and use extra evaluation to confirm indicators.
Lack of Directional Information
Bollinger Bands suggest volatility and potential price tiers but do not provide data about the direction of price movement. Traders must depend on different tools or analyses to determine the duration of a breakout.
Optimization Challenges
Finding the most beneficial parameters for Bollinger Bands (e.g., the excellent period and tradable deviation multiplier) can be difficult, as they’ll range for different properties and timeframes.
Market Conditions Matter
Bollinger Bands are more effective in sure market conditions, together with ranging markets, and can be much less useful at some stage in strong trending intervals or whilst markets are rather unpredictable.
Subjectivity
Interpretation of Bollinger Bands can be subjective, and distinct traders can also have varying interpretations of signals.
No Guarantee of Profit
Using Bollinger Bands, like every trading method, does not guarantee profits. Successful trading involves risk management, discipline, and regular learning.
Best Practices for Trading with Bollinger Bands
Here are the tips you should follow while trading with Bollinger Bands.
Stay informed
It is suggested that traders stay informed about Bollinger Bands’ trading strategy. You should stay updated with market news and price movements and make informed decisions. Traders must look for opportunities to buy at the lower Band and sell at the upper Band.
Do regular practice
You have to first start trading on a demo account. The more you do practice, the more you become familiar with Bollinger Bands strategy. It gives you a hands-on approach to getting valuable insights.
Risk Management Strategy
Do not put your whole money on a single trade. You should diversify the trade investments and set stop-loss points to reduce big losses.
Example Trades and Case Studies
Let us take the example of Tech stock, “techno” in late 2020. They use the Bollinger Squeeze strategy. It broke out above the upper Bollinger bands. This breakout combines with a spike in trading volume and indicates a strong bullish trend. In the market, the USD/EUR pair shows the example of Bollinger bands in action. During the uncertainty in the market, the pair touched lower Bollinger bands and showed a strong oversold condition. It shifts the market sentiment. An uptrend in trading volume confirms this movement. It shows the traders how to make long entries.
The traders who use Bollinger bands will strengthen their trade. They can do it when they implement the strategy. For example, a price near the upper Band shows bullish strength. Closing the ear to the lower Band can indicate bearish trends. Traders need to consider the market indicators while making trading predictions.
Advanced Applications and Considerations
Experienced traders regularly combine Bollinger Bands with traditional chart styles. Examples consist of double tops/bottoms. Doing so enhances the predictive strength of their techniques.
Traders can also regulate and read the Bollinger Bands parameters based on their particular trading style. They don’t forget to trade the asset. The turntable putting is a 20-day SMA with standard deviations even though. Shorter time frames can use a 10-day SMA for more sensitivity.
It’s important to apply Bollinger Bands. They form part of a complete risk management technique. It enables control of risks. They can offer valuable market insights. However, traders need to not use them in isolation for making trading decisions.
Conclusion
Bollinger Bands play a vital role in technical trading. It is the best technical analysis tool that helps traders measure market volatility, check price movements in the market, and set entry and exit points. It reduces the risks of traders and keeps them updated with market news and price changes. You can increase the trading success by combining the Bollinger Bands with other technical analysis tools.
It is suggested that traders combine the Bollinger Bands with the Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD). This combination builds your strong foundation for trading and makes it adaptable to different demands of market volatility.
You have to maintain your disciplined approach and perform consistent trading to get the benefits of Bollinger Bands. By looking at insights drawn down from dynamic bands, traders can unlock the potential and get help to navigate through the complex world of trade. It not only provides you with profitable opportunities, but also unlocks your success with technical analysis, and makes you adaptable in the trading market.
