Bollinger bands full guide
Bollinger bands have become one of the most useful and commonly used tools between traders and investors. In this article, we are going to learn what this tool is, how it works and whether it is useful or not with simple words.
What are Bollinger bands?
Bollinger Bands is a well-known indicator of technical analysis that provides traders or investors more information about the currency pair or stock in the market. In simpler terms, the Bollinger Band indicator is used to measure market volatility. This technical analysis tool consists of two top and bottom bands, which are separated by a central line. The central line is the moving average.
The Bollinger Bands indicator was first introduced in 1980 by John Bollinger. Today, this indicator is one of the most practical and important indicators of the market trends that are used by many technicians. The Bollinger Bands is used to detect trends, understand emotional situations and confirm sales signals. It is used by traders and investors to collect necessary information about currency pairs and stocks. These bands are mainly used to observe market price volatility.
Bollinger bands structure
Bollinger Band consists of two standard deviations (positive and negative) and a simple moving average (SMA)as top, bottom, and middle lines. The top line and the bottom line are separated by the middle line.
Upper band or UP: the high band that its distance is set by the deviation number. This line is placed on top of the middle line in the Bollinger bands and indicates the saturation of the purchase.
Middle line or ML: The middle line is used to show the moving average. Moving average is the average price during the period of time. The moving term is used because the price varies in different time periods.
Bottom line or LB: The bottom line’s distance is set by the deviation number. This line is placed under the middle line and represents the selling pressure.
Bands are also known as price channels. They would be separated by high price volatility and closed to each other by low volatility. Basically, the channels coordinate themselves with the price movement and include price fluctuations. Bollinger Band settings are very simple first step is to set the moving average line of the indicator, which is normally above 20. The next step is the top and bottom lines which are set to the number of deviations.
In the chart above a simple 20-day moving average is surrounded by up band and down band along with daily stock price movements. Because standard deviation is used to measure market volatility, when the market is volatile, bands become wider. While they are denser during periods of less volatility.
How to calculate Bollinger bands?
The first step is to calculate the simple moving average of any particular and desired securities (often using a simple 20-day moving average). A 20-day moving average can calculate the closing prices for the first 20 days as the first data points. The next data point removes the previous price and adds the price of day 21 and averages until the end.
In the next step, the standard deviation of the price of the securities is calculated. The standard deviation is the mathematical calculation of average variance and has special application in statistics, economics, accounting, and finance.
BOLU= MA(TP,n) + m*Ϭ[TP,n]
BOLU= MA(TP,n) – m*Ϭ[TP,n]
BOLU = upper band
BOLD= lower band
MA = moving average
TP( Typical Price)= (Closing price + low price + high price)/3
n = smoothing period
m = Number of standard deviations
Ϭ[TP,n]= Standard deviation during the last n period of the typical price
How is it useful?
The Bollinger Bands indicator bands show prices close to the moving average (middle line). The lower the moving average is, the smaller the bandwidth would be.
In the Bollinger Bands indicator, the bands move closer together or distant from each other based on the moving average. When price movements and volatility are high, Bollinger Bandwidth increases and band distances increase as well. On the other hand, as the volatility and price movements decrease, the bandwidth of the Bollinger Bands decreases and the bands get closer to each other.
Bollinger Bands set a price target. If the price moves from the top band to the bottom band, it indicates that the next target price can be predicted in the lower band, and vice versa. If the bandwidth increases abnormally, it indicates a warning that shows the previous trend is ending. While in case the bands are close together and the bandwidth is unusually low, it indicates a warning that a new trend is beginning.
This is one of the most important uses of this indicator in sales signals. If a candlestick is placed above the moving average line known as midline or if the candlestick exit the upper band, a buy signal will be issued for the new trend ahead. Also, if the candle bandwidth decreases and place under the moving average band or the candle exist the lower band, indicates a downward trend and a sell signal will be issued.
If the bands move away from each other, the weakening of trends is indicated. The failure of Bollinger Bands is when the price is recorded outside the Bollinger Bands.
What do the bands tell you?
Bollinger Bands are a very popular technique. Many traders believe that the closer the price moves to the upper band, the more the market is overbought, and the closer the price moves to the lower band, the more the market is oversold.
The Bollinger squeeze is the main concept of Bollinger Bands. Squeeze refers to bringing these bands closer together and shrinking the moving average. Squeeze indicates a period of low volatility trading that traders see as a potential sign of a volatile future that provides opportunities for trading. On the other hand, the farther apart the bands are, the less likely they are to fluctuate and the more likely the trader is to exit the deal. However, these conditions are not trading signals. These bands do not specify when these changes will occur and where the price may move. So this tool, along with other tools, can be used for buying and selling, and it cannot be used solely for efficient results.
Approximately 90% of the price action takes place between the two bands. Any breakout of the up or bottom bands is considered an important event. Breakout is not a trading signal. The mistake that can easily get your claim denied is to assume that breakouts are selling or buying signals. breakouts are no indication of the direction or size of the price movement in the future.
breakouts occur after a period of stabilization and when the price approaches the out-of-band range. The important thing to keep in mind in cases of breakout occurrence is that you better use support and resistance lines to be more confident about how the stock price is going to go. When the stock price trend tends to rise, the moving average line is considered as support. But when the stock price trend declines, the moving average line is considered resistance.
In summary, interpretation of what this method tell us about the market is listed below :
- The upper band shows a level that is expensive
- The lower band shows a level that is cheap
- The Bollinger bandwidth correlates to the volatility of the market
- In a more volatile market, Bollinger bands are distant from each other
- In a less volatile market, the bands are close to each other
Bollinger Bands in Forex and Binary Options trading
In binary options, it is used to analyze chart fluctuations. Traders use this indicator as part of their trading system to provide better trading opportunities. The first thought that comes to the mind of binary options traders is the idea of price movement in the channels. Price always wants to stay between channels. But sometimes the chart pulls out of the top or bottom of the band, and that’s a sign of a price reversal. If the upper band hit the price trader would understand it is selling time. This is because the price wants to return to its previous position in the channel. Similarly, when the price goes beyond the lower band, it is time to buy.
About 95% of the time, the price stays in the channels and 5% goes out of bands. For the option trade, when at least two candlesticks are opened outside the upper or bottom line, is the best time to open the trade with hopping that the price will return to the middle line.
However it is suggested that not use the Bollinger Band indicator as a buy and sell signal. Use this indicator as a tool to confirm the trades and as a complement to the rest of your indicators.
Bollinger bands in cryptocurrency trading
Cryptocurrency traders and investors use Bollinger bands in several different ways. The first useful thing that can be gleaned from this method is the volatility of any particular coin. As mentioned earlier Bollinger bands squeeze when standard deviations are low, which is a sign for a period of low volatility. On the other hand they tend to expand when volatility increases, as the standard deviations increase. Depending on different cryptocurrency coins trading in the market, this information can have several meanings. Determining the volatility is increasing or decreasing, which can point to investment opportunities or an upcoming breakout in the price.
As soon as the market price movements get out of the bands, traders should attention. Once the coin is overbought price trend would be above the band and it would be an ideal time to sell before prices fall back. On the other hand when the coin is oversold price trend tags at or below the lower band and it is an ideal time to buy.
Another application of this method in cryptocurrency trading is that movements at the Bollinger band boundaries can determine near-term price direction. In case the price gets to a level at or below the upper band, prices would generally move up. While in cases that prices dip below the band then the price trend is headed down.
Generally, Bollinger bands are a great method of looking at the cryptocurrency market. In simple words buying in the market would be a good idea when the coin’s price is between the moving average and the bottom band and selling is the correct decision when the coin is between the moving average and the top band. Many advanced traders use other indicators like volume indicators before placing their bets based on this method.
Limitations of Bollinger Bands
It is not an independent trading system. The bands only formulate an indicator that is designed to provide traders with information about price volatility. John Bollinger’s suggestion is to use this tool with two or three unrelated indicators that provide more direct signals from the market. According to Bollinger, the market analysis should use different indicators based on different types of data.
Since Bollinger Bands are calculated based on a simple moving average, they give older data a similar weight value to newer data, meaning that new information may lose its importance due to older data.
Although Bollinger introduces the number 20 as a suitable interval for drawing the moving average, and the type of moving average suggested by him is simple (Simple Moving Average) but Keep in mind that using a simple 20-day moving average and two standard deviations is somewhat optional and may not work well for every trader in every market situation. Traders must therefore adapt and monitor their assumptions about simple moving averages and standard deviations. However, it is notable that according to Bollinger the moving average of fewer than 10 days does not work well for drawing Bollinger Bands.
In short, the Bollinger Bands show the fluctuations that occur at any given time in the market and alerts the analyst to the highest and lowest prices. The tool also helps traders who are looking for good opportunities in the market range, in buying and selling saturation points. When using this indicator, you should keep in mind that it should be used in conjunction with other technical analysis tools.