In this tutorial, you’ll learn everything you need to know about Bollinger Bands.
The Bollinger Bands (BB) is a trendy technical analysis instrument introduced by John Bollinger in the early 1980s.
What are the Bollinger Bands?
Bollinger Bands consist of two lines, both above and below a central moving average, which covers the price.
Generally, the center Moving Average line is a 20-periods SMA. This moving average serves as the basis for the upper and lower bands calculation.
Typically, the upper and lower bands are set to two standard deviations of the SMA (the intermediate line); however, the trader can also adjust the number of standard deviations.
It turns out that with these types of parameters, statistics show that 95% of the price should remain within these bands.
The Bollinger Bands indicator reflects the current changes in market volatility and confirms the direction.
The Bollinger Bands, also, warns about the possible continuation of the trend or vice-versa its termination.
The indicator can indicate local highs and lows.
The peculiarity of Bollinger Bands consists of their variable width due to price volatility. During periods of significant price fluctuations, the bands extend leaving prices more space.
During periods of low volatility, the bands are chosen to keep prices within their margins.
The price movement that has started from a margin of the band usually reaches the opposite margin.
Bollinger Bands – Calculation Tutorial
MMS = Sum of the closing price for 20 days / the number of days.
Here we add two standard deviations to the value obtained from the 20-period moving average.
Here we eliminate two standard deviations from the value obtained from the 20 periods moving average.
As we have mentioned, the moving average that is usually used is that of 20 periods, but we can modify that value when circumstances force us to do so.
As the number of periods involved lengthens, the number of standard deviations used should be increased.
How to use Bollinger Bands
The increasing distance between the upper and lower moving average, accompanied by increasing volatility, indicates an upward or downward trend, depending on the direction of the moving average.
On the contrary, if the distance between the means falls, with the volatility descending, a neutral tendency is presented.
If the price grows above or falls below the upper or lower moving average, the trend may continue (volatility increases), as well as change (volatility decreases).
In the same way, any scenario must be confirmed by other indicators, such as ADX (Directional Average Index) or RSI (Relative Strength Index).
Likewise, the price intrusion with the middle band from below or from above represents a signal to buy or sell respectively.
The application of the Bollinger Bands strategy is to obtain benefits from the market state in the area of overbought or oversold.
Prices can be considered to be overestimated when they reach the upper band (overbought zone).
And on the contrary, prices are underestimated if they reach the lower band (oversold zone).
If the price moves below a certain simple moving average, then the lower band will become the lower limit of the price target.
If the price moves above the same simple moving average, then the band will become the upper limit of the price target.
We can assume that there is an upward trend if the lower price falls in the middle band, this warns us that the trend changes by a downward trend.
If the price rises higher in the middle band, this warns us that the trend changes to an ascending one.
Bollinger Bands – Interpretation Tutorial
We can observe different phases depending on whether the market is in range or trend.
This allows us to identify volatile situations and, by default, periods in which there is little volatility in the asset.
Depending on the functioning of the market, a volatility phase is followed by a period of calm or range.
If in periods of strong movement the bands deviate more than usual, during periods of range, the process is reversed, and an approach of these same bands is observed, informing us of the context of the market in which we evolve at this precise moment.
When the Bollinger Bands deviate, the slope of the bands will follow that of the central moving average and, therefore, will go up and down.
The phases of tendency begin mainly by the rupture of the previous ran.
The candle outside one of the two external bands, well above or below the recent movements, signals a risk.
Trend traders will look for price outings beyond Bollinger bands to capture range breaks and take advantage of the new trend that is forming as soon as possible.
Bollinger Bands and Envelopes Indicator
The difference is that the margins of the Commercial Channels (Envelopes) are below and above the curve of the moving average at a fixed distance expressed in hundreds.
The margins of the Bollinger Bands are drawn at distances that are equal to a certain number of standard deviations.
Since the value of the standard deviation depends on volatility, the same bands adjust their width.
It increases when the market is unstable, and it decreases during periods of more stability.
MORE FROM FINANCE STRATEGY SYSTEM