It’s time to take a look at Bollinger bands. And no, unfortunately, it’s nothing to do with champagne.
Bollinger bands are a technical analysis tool invented by John Bollinger. (Who also wrote the imaginatively titled book Bollinger on Bollinger Bands). Basically, they work by measuring the “highness” or “lowness” of a price, compared to previous trades.
They’re made up of a moving average with upper and lower bands based on standard deviations.
FOR EXAMPLE…
A common setting for a Bollinger band is a 20 period moving average with the upper and lower bands set at 2 standard deviations.
Why Use Standard Deviations?
Standard deviations can be used to gives you an idea of how much the price you are looking at varies from the average over a period of time.
In a totally random set of results, you would expect to see 95% of all results falling within 2 standard deviations, and more than 99% to be within 3. So applying this to trading, IF price is completely random, then there’s a very good chance that the next price the market makes will fall somewhere between the upper and lower Bollinger bands.
Of course, this all depends on price being random, and whether this is true or not is an argument for another day. However, even if price is not random, Bollinger bands are still useful to provide an indication of how far price is likely to move in a certain period.
How To Make Bollinger Bands Work For You
Bollinger bands can be applied to both trending and non-trending markets using a slightly different strategy for each environment. Let’s take a look at both, and the best ways to analyse them…
1. Trending Markets
In a trending market, price will be pushing in a particular direction, pushing on either the upper or lower Bollinger band, depending what direction it’s moving in.
This is shown in the chart below:
HOW TO DO IT:
In a trending market, the best way to use Bollinger bands is through the pull back strategy.
Bollinger bands can allow you to use a pull back towards the moving average to enter into the direction of the trend.
WHY IT’S USEFUL:
Using Bollinger bands in this way allows you to run tight stops, in order to capture the trend.
DON’T FORGET:
This works particularly well on lower time frames. When used with good risk/reward management, it can be a really good strategy for use on highly traded pairs (like the EURUSD).
2. Non-Trending Markets
In a non-trending market (also known as range bound or choppy), Bollinger bands can act as barriers to price, as shown in the chart:
HOW TO DO IT:
In a range bound or low volatility environments, you need to use Bollinger bands as a guide to how the price may move. You can do this using the fading strategy.
To do this, you need to look for an extreme price movement in low volatility, and then take the opposite position. Then, plot the 20 period moving average, and the 2 and 3 standard deviations on the chart, as shown below:
The final step is to look for the price to hit the outer Bollinger, then move back into the Bollinger range. It if breaks or closes above the inner Bollinger, you can then get in the direction towards the moving average.
Here’s an example of what might happen:
WHY IT’S USEFUL:
This strategy allows you to use relatively tights stops on lower time frames to capture a fade in the opposite direction.
DON’T FORGET:
To make sure you’re in a low volatility environment before using this strategy. (You can do this using ADX or an Awsome Oscilator, or get clues from your moving averages or MACD).
All comments, charts and analysis on this website are purely provided to demonstrate our own personal thoughts and views of the market and should in no way be treated as recommendations or advice. Please do not trade based solely on any information provided within this site, always do your own analysis.
Editors’ Picks
EUR/USD steady below 1.0800 after US PCE meets expectations
EUR/USD remains depressed below 1.0800 after soft French inflation data, amid minimal volatility and thin liquidity on Good Friday. The pair barely reacted to US PCE inflation data, with the Greenback shedding some pips. Fed Chair Jerome Powell set to speak ahead of the weekly close.
GBP/USD hovers around 1.2620 in dull trading
GBP/USD trades sideways above 1.2600 amid a widespread holiday restraining action across financial markets. Investors took a long weekend ahead of critical United States employment data next week. Fed Chair Powell coming up next.
Gold price sits at all-time highs above $2,230
Gold price holds near a fresh all-time high at $2,236 in thinned trading amid the Easter Holiday. Most major world markets remain closed, although the United States published core PCE inflation, the Federal Reserve’s favorite inflation gauge.
Jito price could hit $6 as JTO coils up inside this bullish pattern
Jito (JTO) price has been on an uptrend since forming a local bottom in early January. Since then, JTO has revisited the key swing point formed in early December, suggesting the bulls’ intention to move higher.
Key events in developed markets next week
Next week, the main focus will be inflation and the labour market in the Eurozone. We expect services inflation to be impacted by the easter effect, while the unemployment rate to be unchanged.
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