Developed by John Bollinger, the Bollinger Bands are one of the most powerful trading tools available to traders, and have been used for decades in both Stocks, Commodities and Forex analysis. This article will describe how to trade with the Bollinger Bands and use it to enhance your signals and make them more accurate and profitable.
The Bollinger Bands are volatility indicators. They middle band is a simple moving average of 20-periods, and the upper\lower bands are calculated by adding and subtracting, respectively, the standard deviation of price to the middle band. This means that the difference between the upper and lower band is 2 times the standard deviations. A big space between the two bands means that price is highly volatile, and a small space between the two bands indicates low volatility.
The first method to use the Bollinger Bands is to gauge trend\range. If the Bollinger middle band is flat it means that price is ranging and that the trend is weak, and if the middle band is trending in a direction, it means that price is in strong range. This can help you filter your trades: in ranging markets you should only take reversal trades, and in trending markets you should look for places to join the trend.
Once you've determined the market condition, you can also use the bands to actually signal trading signals: when price is in range, the upper and lower bands often serve as resistance and support levels, respectively. Therefore we enter a short trade if price hits the upper band and reverses, and will enter a long trade if price hits the lower band and reverses upwards. It is recommended to confirm these signals using an existing support\resistance level that is confirmed by price-action, to make the signals more accurate.
Another trading method that uses the Bollinger Bands is the Squeeze. A squeeze occurs when the volatility is low and price is a very tight range. Usually this squeeze results in a very big breakout of the range, and a beginning of a strong trend. Traders can take advantage of this by setting orders right outside the range, to catch the price at the beginning of the trend and harvest the profits. However, this trading method is not so reliable as in many cases price breaks to one side just to reverse and eventually create a trend to the opposite direction.
In conclusion, the Bollinger Bands are very useful trading indicators that you should have in your arsenal.
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