If you’ve been trading for a while, you’ve probably heard of bollinger bands. Bollinger Bands are a widely used technical analysis tool that can help traders to identify trends and potential buy or sell signals in financial markets. The bands consist of three lines: a simple moving average (SMA) line in the center, and an upper and lower band that represent two standard deviations from the SMA.
Picture this: You’ve been watching a stock move lower. And lower. And lower. You’re wondering, “when can I swoop in and buy this thing?” This is a perfect use for bollinger bands – an indicator that can work on any time frame, for bullish OR bearish trades.
Traders use Bollinger Bands to identify when a security is overbought or oversold, which can help them to determine potential price reversals or corrections. In this article, we’ll learn how to trade the Bollinger Bands, including how to set them up, interpret them, and use them to make trading decisions.
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Setting up the Bollinger Bands
To use Bollinger Bands in your trading, you will need to set them up on your trading platform. Most trading platforms, including MetaTrader, ThinkOrSwim, WeBull, and IBKR have simple “on-off” toggles for the bollinger bands. Additionally, TradingView (a popular charting service) offers bollinger bands among their comprehensive list of indicators.
Once you have added the indicator to your chart, you can adjust the settings to fit your trading strategy.
The default setting for Bollinger Bands is a 20-day SMA with upper and lower bands that are two standard deviations away from the SMA. However, you can adjust the settings to fit your trading strategy by changing the period, standard deviation, and SMA type.
Interpreting the Bollinger Bands
When interpreting the Bollinger Bands, there are a few key things to keep in mind. The upper band represents a potential overbought level, while the lower band represents a potential oversold level. When a security’s price approaches the upper band, it may be a sign that the security is overbought and due for a correction. Conversely, when a security’s price approaches the lower band, it may be a sign that the security is oversold and due for a reversal.
In addition to the upper and lower bands, the SMA line can also provide valuable information for traders. When the price of a security is above the SMA line, it may be a sign of an uptrend, while a price below the SMA line may indicate a downtrend.
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Bollinger Band Trading Strategies
Here are three bollinger band trading strategies that traders commonly rely upon.
Bollinger Bands Squeeze Strategy
- The Bollinger Bands Squeeze strategy is based on the idea that periods of low volatility are typically followed by high volatility. When the bands narrow, it suggests that the market is in a consolidation phase and traders should expect a breakout soon.
To use this strategy, traders look for periods where the upper and lower bands are close to each other. When the bands begin to expand, it suggests that the market is breaking out of consolidation, and traders can enter a position in the direction of the breakout. Traders typically use other indicators, such as volume or price action patterns, to confirm the breakout.
Bollinger Bands Reversal Strategy
- The Bollinger Bands Reversal strategy is based on the idea that the price tends to revert to the mean. When the price reaches the upper band, it suggests that the price is overbought, and when the price reaches the lower band, it suggests that the price is oversold.
To use this strategy, traders look for price action patterns, such as candlestick patterns or momentum indicators, to signal a potential reversal. For example, when the price reaches the upper band, and a bearish candlestick pattern forms, traders can enter a short position, expecting the price to revert to the moving average. Conversely, when the price reaches the lower band, and a bullish candlestick pattern forms, traders can enter a long position, expecting the price to revert to the moving average.
Bollinger Bands Trend Following Strategy
- The Bollinger Bands Trend Following strategy is based on the idea that the price tends to move in trends. When the price is trending, the upper and lower bands tend to act as support and resistance levels, respectively.
To use this strategy, traders look for trends and enter a position in the direction of the trend when the price reaches the moving average or the opposite band. For example, when the price is in an uptrend, traders can enter a long position when the price reaches the moving average or the lower band. Conversely, when the price is in a downtrend, traders can enter a short position when the price reaches the moving average or the upper band.
