- August 1, 2020
- Posted by: Brenda Knight
- Category: Consulting
Bollinger Bands are indicators that show a drop or rise in prices on a relative basis. When you start trading, you need to know what is best for you and how to act in the market. As with any craft, you need the right tools to trade. To develop the feeling of a trader and become an equal member of the club, you also need to have a tool that will shape your moves on the path to success with adequate sensitivity. Such a tool exists, developed by John Bollinger. This financial analyst developed the so-called Bollinger Bands. It is nothing but the trends of falling and rising prices shown in the charts.
What to do with the Bollinger Band charts?
By using charts, you can get useful information about determining whether something is being bought too much or sold too much. Remember, this tool is what you need to trade in the market. Adequate for finesse and changing trends to succeed. When you start trading, this tool is what you need to adapt to working conditions and develop your strategy and knowledge. Also, your design in a trade and the road to success too. It is the same as when you need a specialist in a specific field, for example, a mechanical engineer who will calculate the possibility of breaking support and additionally secure that part. Bollinger Bands is just that finesse tool in the field of trade.
Wondering maybe, how do Bollinger Bands work?
As said, this tool visually shows the change in prices, shows changes in volatility. These are the so-called overbought or oversold zones. It is useful to know this because of price differences, and various other parameters can be determined. In this way, you can choose your buying /selling strategy and project a goal with which prices you will trade. Oversold or overbought zones, therefore, tell you about market volatility. In other words, is the market quiet, or is it loud? When on the chart bands contract, then it is said that the market is quiet. When bands spread, the market is said to be loud. Or, when the bands are close to each other, the market is quiet, when the space between bands begins and continues to expand, then the market is loud.
What are the bands measuring?
These bands are measuring volatility, and this is needed to determine the degree of price change over time. The degree of price change is essential in determining a trading strategy, whether to sell or buy something, and ultimately make money. Let’s see what Bollinger Bands consist of and how useful trading information you can see from them. They are displayed with three lines: the upper band, the middle line, and the lower band. The middle line shows the so-called Simple Moving Average (SMA) over for usually 20 days. I say, usually in a period of 20 days, although an experienced trader can enter an attempt for a longer period, so experiment and thus develop their experiences further.
So, in that case, the trader is experimenting with a different moving average period. Simple Moving Average (SMA) is the base for the other two lines: upper band and lower band. While the other two lines, upper band, and the lower band used to measure volatility. In fact, the deviation of these two bands, upper and lower, from the SMA are measures that determine volatility. Of course, the trader can always adjust these deviations. The point is that with increasing volatility, the deviation of bands is greater.
Conversely, with decreasing volatility, the deviation of the bands is less, that space between them becomes narrower. These two bands, therefore, represent two standard deviations (SD), above and below the midline (SMA). The standard deviations, either above or below the middle line, shows how much the values deviate. As I mentioned, these measures show how much the prices, i.e. the numbers, are wider or closer. Standard deviations expressed in numbers.
Let’s make an example.
If, for example, the standard deviation expressed by the number 1, it means that about 68% of the price movement, contained between the two bands, has appeared recently. If the standard deviation between the bands is number 2, then the price movement is about 95%, contained between the bands has occurred recently. Of course, the greater the distance between the bands, which means that the higher the standard deviation, the more prices are contained between the bands within the deviation. With the experience gained during the trade and the development of the feeling of a trader, you will be able to try different standard deviations.
Beginners also need to know the parameters, and how they are marked. The first parameter is Period (20). It is, therefore, a period or number of bars, and a trader uses it for calculation. According to the recommendation of John Bollinger himself, the optimal period or number of bars is 20 or 21. According to him but in the form of a warning, periods containing less than ten periods do not work well. The second parameter is Band Width (2). It is nothing but half the width of the band, in terms that are multiple of the standard devotion (SD). Usually, “2” is used as recommended.
Ok, what next?
Once you know all the necessary concepts and parameters, you first need to calculate the Simple Moving Average (SMA). Then you calculate the Standard Deviation (SD). Here you make sure that the Standard Deviation calculated for the same number of periods as the Simple Moving Average. Next, for the upper band, you need to add the value of the Standard Deviation to the Simple Moving Average. On the other hand, for the lower band, subtract the Standard Deviation value from the Simple Moving Average. Typically, short term, medium-term, and long term values used in the calculation of Simple Moving Average and other related parameters. The short term contains a 10-period moving average with a standard deviation of 1.5. Medium-term contains a 20-period moving average with a standard deviation of 2. Long term contains a 50-period moving average with a standard deviation of 2.5.
Next thing that beginners should know that prices tend to return to the middle line. It is the idea of “Bollinger Bounce.” If the price has reached a peak within the deviation, that is, it is at the top of the band, its trend is that it will start to fall. That’s right, it falls towards the middle line, towards the middle area of the bands. This price drop towards the middle area of the bands is Bollinger Bounce.
Why does the Bollinger Bounce occur?
It occurs because Bollinger Bands operate on the principle of dynamic support and resistance levels. You need to know that this strategy is well when there is no clear market price trend. With enough experience, like all other experienced traders, you will be able to develop trade systems based on Bollinger Bounce. I repeat, only when there is no clear trend, and when the market is ranging, you need to use this trading system. It again means you need to take into account the width of the bands. You do not want to use Bollinger Bounce when bands are expanding. Then prices move in trend, so there is no ambiguity about the trends. Prices then do not move in range. So, do not use it when the bands are expanding, but when they are stable or contracting.
What’s Bollinger Squeeze?
Another term is Bollinger Squeeze. When bands happen to squeeze together, it means a breakout is about to happen. If the candle on the chart starts to break and moves above the top band, then it will usually continue to go up. Then, that is a trend. So, this system you use when there a market is trending. Also, when the candle breaks through the lower (bottom) band, it will usually continue the downward trend. It is how the Bollinger Squize system works.
Every time you see bands squeeze together, you need to react as soon as possible and catch that move. When you see such a situation that bands squeeze together you are sure how the price will move: up or down. You will not see opportunities like this every day, but several times during the week for sure. Therefore, you need to apply the mentioned persistence in monitoring the movement of all changes in the market. With these two mentioned strategies Bollinger Bounce and Bollinger Squeeze, you will encounter most often while using this system.
So, how exactly should I use the Bollinger Bounce and Bollinger Squeeze?
So, it is not overwhelmed to repeat. Use Bollinger Bounce when there is no clear trend, while use Bollinger Squeeze when there is a trend. But be careful when the trend is about to begin. In other words, if the bands are tight, and that happens during low volatility, the probability of a sharp price in one of the two directions begins to grow. It most likely marks the beginning of a trend. Here you have to watch out for false movements of the trend in the opposite direction that will occur before the trend starts moving in the right direction. Also, that feeling of knowing the aforementioned false movements before the appearance of the real ones, you will gain the experience and perseverance.
On the other hand, when the amount between the bands is unusually high, which means increased volatility, the existing trend is likely coming to an end. Besides, prices tend to jump within bands. More precisely, they bounce. In other words, they touch one band then move and touch another band. For example, if the price bounces off the upper band and crosses the middle line (moving average), then the lower band will become a target for profit, it means a particular action, purchase, sale, etc. So-called strong trends should also be taken into account.
That means when the price sticks to the band envelope over a long period. There you always do additional research to determine possible oscillations of the favorable moment for a timely reaction.
These are all the initial information and terms which you will gain during the acquisition of the routine. These terms will become reliable signals for timely purchase or attachment. You will learn to buy or sell at the right moment!
In case you need any help with this or some other terms, feel free to contact us and we’ll do our best to help you, free of charge!