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What Is Bollinger Band Indicator?

What Is Bollinger Band Indicator?

Have you ever heard of something called "Bollinger Bands"? Don't worry if it sounds a bit technical – I'm here to explain it in a way that's easy to understand. Bollinger Bands are like price lines that help us figure out whether something is cheap or expensive, just like when you shop for clothes or groceries.

What are Bollinger Bands?

Bollinger Bands were created by a person named John Bollinger. These bands show us a range of prices that something, like a stock or currency, usually stays within. Imagine it like a high and low price range for something you want to buy. These bands move up and down based on how much the prices change over time.

To use Bollinger Bands, we need to know two things: "Period" and "Standard Deviations." These are like the ingredients we use to cook something delicious. The default settings are 20 for the period and 2 for standard deviations, but you can change them according to what you like.

The Bollinger band indicator is mostly used in intraday trading and You can learn how to use Bollinger band indicator in our technical analysis course.

What's the Point of Bollinger Bands?

The main goal of Bollinger Bands is to help us know if prices are too high or too low. They work best when we use both the upper and lower bands together. They are like a pair of glasses that help us see things clearly. These bands also work better when we use them with something else called a "moving average." This helps us make better decisions about when to buy or sell something.

Understanding Bollinger Bands

Think of Bollinger Bands like a line that shows the highest and lowest prices something had over a certain time. The high prices stay close to the upper line, and the low prices stay near the lower line. This line helps us see patterns and trends in prices. When things are changing a lot, the line becomes wider, and when they're not changing much, it becomes narrower. This line also tells us if something is too cheap or too expensive compared to how it usually is.

Bollinger Bands Formula

Calculating Bollinger Bands is like following a recipe. We use three important things:

Simple Moving Average (SMA): This is the average of the prices over a specific time. For example, if we look at 20 days, we add up the prices of those 20 days and then divide by 20.

Standard Deviation: This shows how much the prices change from the average. It's like a measure of how crazy the prices are dancing. We use the same time period as the SMA.

Upper and Lower Bands: Bollinger Bands have a middle line (SMA) and two more lines above and below it. These lines show the price range that's considered normal. The upper and lower bands change based on the standard deviation and how far prices are from the average.

Here's the math for making Bollinger Bands (using 20 days and 2 standard deviations):

● Upper band = 20-day SMA + (20-day SD x 2)

● Middle band = 20-day SMA

● Lower band = 20-day SMA – (20-day SD x 2)

Using Bollinger Bands is like having a magic tool for trading. Let's see how:

● When prices are going up a lot, they often touch the upper band. This means things are getting more expensive.

● If the price goes down a bit and then goes back up, but not all the way to the upper band, it's still strong. This is a sign to buy when the price goes up again.

For Selling in Down Trends:

● When prices are going down a lot, they often stay near the lower band. This means things are getting cheaper.

● If the price goes up a bit and then comes back down, but doesn't go above the middle band, it's still a strong downtrend. This is a sign to sell when the price goes down again.

Spotting Patterns: W-Bottoms and M-Tops

These are like special shapes that Bollinger Bands help us see:

W-Bottoms: When the price goes low but not below the lower band, and then goes up again, it makes a "W" shape. This can mean prices might go up soon.

M-Tops: When the price goes high but not above the upper band, and then comes down, it makes an "M" shape. This can mean prices might go down soon.

Best Bollinger Bands Strategy

If you're looking to make smarter trading decisions, there's a helpful strategy involving Bollinger Bands that can guide you. Bollinger Bands might sound complicated, but we'll break it down into easy steps that anyone can understand.

Bollinger Bands are like virtual boundaries for stock prices. They help us figure out when a stock might go up or down. Imagine a rubber band around the price of a stock. When the rubber band is stretched a lot, it might snap back. Bollinger Bands work in a similar way. They show us when prices have moved away from their usual range, which could mean they'll come back soon.

Figuring out the market's details in a short timeframe by just looking at Bollinger Bands can be a bit tricky. But don't worry, we have a strategy that might help. Imagine Bollinger Bands like a stretchy band around the price. Sometimes, this band gets really tight, like it's squeezing the price. We call this the "Bollinger Band Squeeze pattern." This doesn't happen super often, maybe every 2 to 4 days or weeks. When you see this Squeeze pattern, it could mean there's a chance to make a trade.

Look at the picture below, you'll see rectangles highlighting the Squeeze patterns. If the squeeze lasts for a longer time, the trade you make might be bigger. Also, make sure to trade in the same direction as the breakout. This Bollinger Bands' Squeeze strategy is considered one of the best ways to reach your trading goals.

When prices stay in one place or move just a little, Bollinger Bands get close together. But here's the thing: when you're trading, it's smarter to use Bollinger Bands along with other signs, not just on their own. Taking time to understand the trends before you decide to buy or sell is really important.

Bollinger Bands Breakout Strategy

The Breakout Plan using Bollinger Bands, made by Chuck LeBeau and David Lucas in their 1992 book, works like this: if the price goes above the upper Bollinger Band and closes there, you might think about buying the next day. If the price goes back inside the band, you might want to sell. The opposite happens if you're selling: if the price goes below the lower Bollinger Band and closes there, you might consider selling. If it comes back inside the band, you could think about buying.

A "Simple Moving Average" (which is just a fancy name) of how prices close every day decides the center of the Bollinger Band. The top and bottom parts of the band are set using a certain number of times the standard change from that moving average. This helps figure out how wide the band is. This wider part is called the "channel." It tells us where prices might go.

The Breakout Plan starts the next day when the price closes above the upper Bollinger Band or below the lower Bollinger Band. It's time to leave the trade when the price goes back inside the Exit Band. This Exit Band is determined by another number of times the standard change from the moving average, just like the Entry Threshold.

On the day you start the trade, this Exit Band is your stop. This helps you decide how much to trade using a certain formula.

Parameters of Bollinger Bands Breakout Strategy

Three Parameters Shaping Bollinger Breakout Trading System's Entry and Exit:

Three Numbers that Control When to Get In and Out:

Close Average: This tells us how many days we should use to figure out the center of the Bollinger Band.

Entry Threshold: This number decides how wide the band should be. It also helps us know when to start a trade if the price goes over this number of times the standard change from the moving average.

Exit Threshold: If this is zero, you exit when the price is below the moving average. If it's higher, you leave when the price is below a different number of times the standard change. If it's a negative number, you leave when the price is below the moving average plus that number of times the standard change.

For example, if the Entry Threshold is 3 and the Exit Threshold is 1, you might start a trade when the price is more than 3 times the standard change above the moving average. You might leave when it's less than 1 time the standard change above the moving average.

So, in simple words, Bollinger Bands are like stretchy bands around prices. When they squeeze, it's a sign to pay attention. And the Breakout Plan helps you decide when to trade and when to stop based on these squeezes and movements. Just remember, it's wise to use Bollinger Bands along with other hints, and take time to understand how things are going before you make decisions about buying or selling.

Double Bollinger Band Strategy

The Double Bollinger Band strategy presents traders with an uncomplicated yet powerful approach to enhance their trading choices. Here, we explain the crucial elements of this strategy and present easy explanations to facilitate its application.

Required Components:

1. Two Bollinger Bands:

● Bollinger Band 1: With a length of 20 and a standard deviation (StdDev) of 1.

● Bollinger Band 2: Also having a length of 20, but with a StdDev of 3.

2. Confirmation Indicators:

RSI (Relative Strength Index): Used for trend identification.

Stochastics (Stoch): Employed for entry and exit confirmations, along with overbought and oversold indications.

3. Risk Reward Ratio (RRR):

Recommended RRR: 1:2 or 1:1.5; This should be adjusted according to your risk tolerance.

4. Rules of Engagement:

Entry Signal:

● A candlestick crossing above/below the Bollinger Band with StdDev 1 triggers an entry signal.

● Successive candles following the initial crossover are potential entry opportunities.

● Place the stop loss at the high or low of the crossover candle, or at the middle line of the Bollinger Band—whichever is closer.

● Set the take profit target at a ratio of 1:2 or as per your personal risk comfort.

Avoid Under These Conditions:

● Do not trade if candlesticks show extended bodies or long wicks that cross the Bollinger Band with StdDev 1.

● Ensure alignment: The trend of the candlestick, RSI, and Stoch should all fit together.

● Entry must happen within two candlesticks following the initial Bollinger Band crossover with StdDev 1.

Key Focus: Stop Loss Placement

● Accurate calculation of the stop loss is of utmost importance. Do not initiate a trade until you fully understand the process of determining an appropriate stop loss.

● Calculate the stop loss before making an entry to keep it minimal. For instance, within the Nifty index, a recommended limit of 40 points is suggested.

FAQs

Que 1. What are the limitations of Bollinger Bands?

Ans: While Bollinger Bands offer valuable insights for technical traders, it's essential to acknowledge their limitations before implementing them. One key limitation to note is that Bollinger Bands are fundamentally reactive in nature, lacking predictive capabilities. These bands respond to price fluctuations, whether in uptrends or downtrends, but they do not forecast future prices. Much like many other technical indicators, Bollinger Bands exhibit lagging tendencies in their indications. This can be attributed to their foundation in a simple moving average, which calculates the average price across multiple price bars.

Que 2. Which is the best indicator to use with Bollinger Bands for intraday trading?

Ans: For intraday trading, Bollinger Bands are frequently paired with the relative strength indicator (RSI) and the BandWidth indicator. The BandWidth indicator quantifies the width of the bands relative to the middle band, providing further context to market dynamics.

Que 3. What is the accuracy of Bollinger Bands?

Ans: Bollinger Bands have the capability to encompass approximately 90% of the price movement within a specific asset or cryptocurrency. Instances where the asset's price surpasses or falls below a designated Bollinger band indicate the emergence of potential trading opportunities.

Que 4. Is Bollinger Band a lagging or leading indicator?

Ans: Bollinger Bands can be classified as lagging indicators due to their construction around a 20-day simple moving average (SMA) along with two outer boundary lines. These outer bands represent positive and negative standard deviations from the SMA, serving as a measure of market volatility.

Que 5. How to prevent Bollinger Bands from generating fake signals?

Ans: To reduce the likelihood of false signals and erroneous fluctuations when employing Bollinger Bands, integrating volume as a confirmation tool is advisable. Generally, instances of high volume coinciding with price breakouts beyond the upper or lower bands indicate robust buying or selling pressure, potentially signaling a shift in the prevailing trend.