Bollinger Bands: how to combine with other indicators
Bollinger Bands were developed and published in the 1980s by the financial analyst John Bollinger in his book Bollinger on Bollinger Bands.
Bollinger came up with the bands as a way to show price changes in a more dynamic way than the traditional support and resistance levels. In addition, he found that the bands provided a valuable framework for identifying potential trading opportunities and managing risk.
What are Bollinger Bands?
Bollinger Bands are a technical analysis tool that consists of three lines: an upper, a lower, and a middle line, which is usually a simple moving average. The bands widen and narrow depending on how volatile the market is. This makes them helpful in finding possible breakouts, changes in trends, and levels of support and resistance.
The upper and lower bands are calculated as a specified number of standard deviations away from the middle band.
The formula for calculating Bollinger Bands is as follows:
Middle Band = n-period simple moving average (SMA)
Upper Band = Middle Band + k x Standard Deviation
Lower Band = Middle Band - k x Standard Deviation
n is the number of periods used to calculate the moving average
k is the number of standard deviations to add or subtract from the middle band
Standard Deviation is a measure of volatility that shows how much the price has fluctuated from its average value over a particular period.
By default, n and k are set to 20 periods for the moving average and two standard deviations for the upper and lower bands. However, traders may adjust these values based on their trading style and market conditions.
The bands expand and contract based on the market's volatility, making them helpful in identifying potential breakouts, trend changes, and support and resistance levels.
Market conditions and trading strategies:
Bollinger Bands work well in markets with high volatility, such as the Forex market.
They can identify potential trend reversals and set entry and exit points.
The most common strategy is to use the bands as indicators of current support and resistance, buying when the price is near the lower Bollinger Band and selling when the price is near the upper Bollinger Band. However, they can also be used to trade breakouts and trend reversals, usually in conjunction with other technical indicators to confirm their trading decisions:
Bollinger Band Squeeze Breakout:
In this strategy, a trader looks for a "squeeze" in the Bollinger Bands, which occurs when the upper and lower bands come close together, indicating low volatility. The idea is that when a squeeze occurs, it often precedes a breakout move in price. Once the Bollinger Bands have squeezed, a trader may wait for a breakout above the upper band (a bullish breakout) or below the lower band (a bearish breakout) to enter a trade. Some traders may also use other indicators, such as the Relative Strength Index (RSI), to confirm the breakout signal.
Bollinger Band Expansion Breakout:
In this strategy, a trader looks for a breakout move after a time when volatility has gone down. For example, after a period of low volatility, the Bollinger Bands may expand, indicating that the market is becoming more volatile. Once the Bollinger Bands have expanded, a trader may wait for a breakout above the upper band (a bullish breakout) or below the lower band (a bearish breakout) to enter a trade. Traders can also confirm the breakout signal with other technical indicators, such as the Moving Average Convergence Divergence (MACD).
Bollinger Bands and RSI:
This strategy uses Bollinger Bands and the Relative Strength Index (RSI) to determine when a stock has been overbought or oversold. For example, when the price hits the upper Bollinger Band, and the RSI is above 70, a trader may look for a sell signal. Conversely, a trader may look for a buy signal when the price hits the lower Bollinger Band and the RSI is below 30.
Bollinger Bands and Stochastic oscillator:
The stochastic oscillator can identify potential reversal points. For example, when the price hits the upper Bollinger Band, and the stochastic oscillator is above 80, a trader may look for a sell signal. Conversely, a trader may look for a buy signal when the price hits the lower Bollinger Band and the stochastic oscillator is below 20.
Bollinger Bands and Moving Average:
This strategy combines Bollinger Bands and a longer-term moving average to identify trend direction. For example, before making a trade, a trader may use the Bollinger Bands to find out if the trend is overbought or oversold and then use the moving average to confirm the direction of the trend.
Bollinger Bands and Fibonacci Retracement:
This strategy uses Bollinger Bands and Fibonacci retracement levels to find possible support and resistance levels. For example, a trader may use the Bollinger Bands to identify the current trend and then use Fibonacci retracement levels to identify potential levels where the price may bounce back or reverse.
Many forex day traders use Bollinger Bands, a well-known technical analysis tool. They work well in markets that are very volatile and can be used to find trading opportunities and decide when to enter and leave the market.
However, traders should also be aware of the limitations of Bollinger Bands and use them in conjunction with other technical indicators and fundamental analysis.