Bollinger Bands Explained: guide & technical implementation

Bollinger Bands is a technical analysis tool developed by John Bollinger in the 1980s to help investors and traders gauge market volatility and identify when securities are poised to rise or fall. When the price touches the upper or lower band, some traders interpret it as an overbought or oversold signal, respectively. One of the core reasons why Bollinger Bands are so widely adopted is their ability to dynamically adapt to changing market conditions. Many traditional technical indicators, like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD), operate within predefined ranges. However, Bollinger Bands adjust to volatility in real-time, making them effective in both trending and ranging markets. Of course, Bollinger Bands trading should not be thought of as a stand-alone system.

The three lines that make up Bollinger Bands are based on a security’s price moves. The center line is the intermediate-term trend and is typically a 20-day SMA of the closing prices. The upper and lower bands are plotted a distance from the SMA set by a certain number of standard deviations, usually two, above and below the center line. One of the main limitations is that it shouldn’t be used as a standalone tool.

What are the most used indicators in combination with Bollinger Bands?

This move created our initial buy signal as prices began to trade outside of the 95% containment region. Additionally, the price broke above the midline to further justify the buy signal. The idea is to use daily charts, and when the indicator reaches its lowest level in 6 months, you can expect the volatility to increase.

• The upper and lower bands are plotted a distance from the SMA set by a certain number of standard deviations, usually two, above and below the center line.
• Traders see increased volatility as an opportunity for substantial gains and a risk of greater losses.
• This made Bollinger Bands highly effective in various markets, including stocks, forex, commodities, and, more recently, cryptocurrencies.
• The Double Bollinger Bands Strategy uses two sets of Bollinger Bands, one with a standard deviation of 1 and another with 2, to analyze market trends and potential trade points.

Dependence on Market Conditions

If the bands remain flat, or one band hooks but the other stays flat, the breakout isn’t there yet. But if you see both upper and lower bands opening up, you know that volatility is rising and a breakout could be about to occur. The screenshot below shows the NZD/USD pair for a day and for 4 hours over the same time period. Go ahead and add the indicator to your charts and watch how prices move with respect to the three bands.

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The consensus is that when the price reaches the upper band, it is considered as overbought, and when the price approaches the lower band, it is deemed to be oversold. To fix this, a trader can look at the overall direction of the price and then only take trade signals buy and sell bitcoin cash bch at the best price in the uk that align them with the trend. For example, only take short positions when the upper band is tagged when the trend is down.

It’s worth noting that Bollinger believes a close either above the band or below the band is not necessarily a reversal signal, but rather a continuation pattern. One technical indicator is not better than the other; it is a personal choice based on which works best for the strategies being employed. Another strategy to use with Bollinger Bands® is called a squeeze strategy. A squeeze occurs when the price has been moving aggressively then starts moving sideways in a tight consolidation. In simple terms, we would say that 95% of all the price action happens in between the Bollinger Bands®.

In the chart below, notice how the Bollinger Bands are on a squeeze pattern and suddenly BOOM! So the formula above is telling us to add all the values of our periods and divide it by the amount of periods we’ll use. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site.

Bollinger Bands Reversal

In practice, Bollinger Bands represent one of the most potent and reliable trading indicators in the world of technical analysis. This indicator is mainly used to interpret the strength of a trend and identify market tops or bottoms. Bollinger Bands® are a pair of lines that respectively represent a positive and negative deviation from the SMA (simple moving average) of a stock’s price. Typically, each band is positioned two deviations away from the respective positive and negative SMA positions. Before Mr. John Bollinger revolutionised the technical analysis world, chartists were using fixed width bands which were not responsive to volatility.

The Bollinger Band Breakout strategy involves entering a trade when the price breaks through the upper or lower bands, signaling a potential continuation of the current trend. Traders can establish long positions when the price breaks above the upper band and short positions when it breaks below the lower band. To manage risk, traders can place stop-loss orders just below or above the breakout point.

To identify this pattern, look for an initial wave in price that’s trending low, where the SMA moves close to or even slightly below the lower band. When it makes this move above the earlier pullback in price, it’s said to be a W-bottom. Then mt4 white label and mt5 white label cryptocurrency trading they proceed to trade on Bollinger Bands when the market is trading in Range (flat) and use the upper band as a sell signal and the lower band as a buy signal.

Especially when combined with other confluence factors such as higher timeframe support and resistance levels and other exhaustion signals. After the push outside the lower Bollinger Bands ®, the trend continued to the downside and the price stayed very close to the lower band. Strong continuation pushes below the lower band confirm the trend direction. In this article, we show you how to use the Bollinger Bands ® indicator to improve your chart reading skills and how to identify high-probability trade entries. Economic announcements, earnings reports, geopolitical events, or sudden shifts in market sentiment can be behind these changes. Traders see increased volatility as an opportunity for substantial gains and a risk of greater losses.

Aside from how the bands/channels are created, the interpretation of these indicators is generally the same. A common approach when using Bollinger Bands® is to identify overbought or oversold market conditions. When the price of the asset breaks below the lower band of the Bollinger Bands®, prices have perhaps fallen too much and are due to bounce. On the other hand, when introducing broker ib registration price breaks above the upper band, the market is perhaps overbought and due for a pullback.