Many believe that applying multiple indicators at once is the key to becoming a professional technical analyst. However, sometimes indicators do not work in that manner. For example, what if the price is above MA20, but the RSI indicates overbought, and APAX signals that the market is in a sideways trend?
So, what should you do? Feeling stuck, right? Don’t worry, because the Bollinger Bands indicator can help you overcome this problem – and more.
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What is the Bollinger Bands?
Bollinger Bands are a technical indicator consisting of three lines created by John Bollinger. It helps you identify market volatility and potential overbought/oversold areas. Therefore, you can rely on the data provided by the Bollinger Bands indicator to develop effective strategies and trades.
Bollinger Bands were created by John Bollinger in 1980. He is still alive and continues to be a famous investor in the market.
John Bollinger had both prestigious degrees in technical analysis and fundamental analysis before the age of 30. He likes playing Sudoku and occasionally provides Bitcoin tips and shares trading experiences on his personal Twitter page. You can follow him at the Twitter address shown in the image below.
Structure of Bollinger Bands
Bollinger Bands are formed from MA (Moving Average) indicator and standard deviation. Its structure is divided into three parts:
- Middle Band: The moving average line, usually the default is MA20.
- Upper Band: Middle band plus 2 standard deviations.
- Lower Band: Middle band minus 2 standard deviations.
You can change MA20 to MA15…, or change the standard deviation at will, depending on your trading style. However, if you are unsure about the market, it is advised to leave the default values.
What is the meaning of the Bollinger Bands?
Based on the Bollinger Bands indicator, you can determine whether the current price is “expensive” or “cheap”. Bollinger Bands provide a relative view of the highs and lows of prices, especially in a sideways market.
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If the price is near the upper Bollinger Band, it is considered “expensive” because it is higher by ~2 standard deviations compared to the average.
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If the price is near the lower Bollinger Band, it is considered “cheap” because it is lower by ~2 standard deviations compared to the average.
However, just because it’s “Expensive” or “Cheap” doesn’t mean you should place BUY/SELL orders immediately.
Because, in a downtrend or uptrend market, the “cheap” or “expensive” levels can be maintained for a long time. Look at the image below to understand better:
⇒ Therefore, remember not to hastily sell or short-sell just because the price touches the upper Bollinger Bands. There is no certainty that the price will decrease.
So, what should you do with Bollinger Bands? Don’t worry, I will guide you more in the section below.
Narrowing and Widening of Bollinger Bands
The change in Bollinger Bands is not just about rising or falling, but it is also noticed by their narrowing and widening.
Narrowing occurs when the two boundary lines of the Bollinger Bands approach the middle moving average, and the distance between the lines narrows. ⇒ The market is experiencing low volatility, so there is a high likelihood of a strong fluctuation and the appearance of new trading signals.
Widening: Similarly, as the Bollinger Bands indicator increasingly widens ⇒ the likelihood of price stabilization increases, and you may consider closing trading positions.
You can rely on these two signals to predict the upcoming market trend and adjust your trading strategy effectively.
How to Trade with Bollinger Bands
How to use the Bollinger Bands? With the Bollinger Bands, you can apply many different trading strategies. Specifically, let’s explore each method together.
Buy Low – Sell High with Bollinger Bands
Buy low – sell high? You may have heard this millions of times. To make money in the market, just buy low and sell high.
But the most important thing is: HOW?
You can use Bollinger Bands: prices near the lower band are cheap, while prices near the upper band are expensive.
But before you think…
“Great! I will buy when the price touches the lower band, and sell when it touches the upper band”
Absolutely do not rush like that. Because using Bollinger Bands in this case also needs to be combined with many other factors. Specifically:
- Use the lower band in an uptrend, and the upper band in a downtrend.
- Look for Japanese candlestick reversal patterns to ensure a reversal will occur.
- The upper/lower bands should coincide with resistance/support zones.
For example: The EUR/USD price is at the low Bollinger Band, coinciding with support and it forms a Bullish Engulfing pattern.
Trading Bollinger Bands Squeeze
Bollinger Bands Squeeze, also known as “bottleneck pattern.” What does the bottleneck pattern look like? It is the areas where price volatility narrows, moving sideways, making the Bollinger Bands look like a bottleneck. Look at the picture below for a clearer understanding:
When the bottleneck pattern appears, there might be a breakout signal out of this area. This is because after some time, investors believe the market has adjusted and accumulated enough, hence deciding to enter a trade.
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Scenario 1: When breaking out of the narrow accumulation area and crossing above the upper band, you can execute a BUY order
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Scenario 2: When breaking out of the accumulation area and the price moves below the lower band, you should execute a SELL order
Tip for you: The longer the volatility contraction, the stronger the next breakthrough will be.
However, there is a problem: although Bollinger Bands indicate that a breakout is about to occur, they do not tell you the direction of the breakout – whether it will be an increase or decrease in price.
The simplest way is to look at the main trend, if it is a downtrend, it is likely to decrease. Conversely, if it is an uptrend, there is a high probability it will increase.
Bollinger Bands and Trend Trading
Bollinger Bands Squeeze helps you determine the future market trend, but it does not help you find a reasonable entry point. So, how to determine the entry point with Bollinger Bands? You can rely on the Middle Band (which is the SMA moving average). This band is used as a dynamic barrier (acting as support and resistance). When the price moves within Bollinger Bands and touches the Middle Band, it is likely to bounce back. Conversely, when the price moves up from below and touches the Middle Band, it is likely to turn down again.
Combining Bollinger Band and RSI
RSI indicator is short for Relative Strength Index, also known as a relative strength indicator. Basically, when this indicator exceeds 70, it is called overbought, and it is time to execute a SELL order. Conversely, when the indicator is below 30, it is called oversold, and you can place a BUY order at this time.
How to use the Bollinger Bands in combination with the RSI indicator? The best way is to look for divergence on the RSI indicator, as this is the time when a reversal is likely to occur. There are two types of RSI divergence:
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Decreasing divergence: When the price movement forms a higher peak after the previous one, but the divergence line tends to decrease.
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Increasing divergence: When the market price movement forms a lower bottom after the previous one, but the RSI line tends to increase.
Both cases are signs of a reversal.
On the chart, draw a Trendline, connecting the peaks. Do the same with connecting the peaks of the RSI indicator. If the price movement on the Trendline is increasing, but the RSI peaks are decreasing, this is a sign of a reversal. You can find the resistance point on the Trendline to exit the trade or when the price cuts below the Middle Band, you set a Stop Loss to cut losses.
For price increases, do the same. Draw a Trendline connecting the price peaks if you see the price decreasing, while the RSI peaks are increasing, it is a sign of reversal. You can find the support point to enter the trade or wait when the price Breakout above the Middle Band, then you can enter a BUY order.
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Bollinger Bands can help you determine if the market price is “cheap” or “expensive.”
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In an uptrend, you can buy near the lower Bollinger Band.
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In a downtrend, you can sell near the upper Bollinger Band.
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Trade when the price touches the upper/lower Bollinger Band and coincides with the resistance/support zone.
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When Bollinger Bands contract, it signals that the market is “ready” for a breakout.
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Preferably look for reversal/continuation candlestick patterns to confirm the accuracy of the indicator.
With the knowledge about the Bollinger Band indicator provided here, do you now know how to use the Bollinger Bands accurately? If you have any questions, please ask us for answers within 24 hours.
