Bollinger Bands

<<<<<<< HEAD

Introduction

In the 1980’s John Bollinger developed his bollinger band theory around moving averages. Bollinger Bands allow us to determine volatility in the market as well as measuring how high/low prices are relative to their historical price action. Bollinger bands comprise of an upper, lower and centre band. The centre line in the band is a simple moving average (SMA) usually set at 20 periods and the upper/lower bands represent chart points that are 2 standard deviations away from the average. Price should normally fall within the upper and lower bands. When the bands widen, volatility increases and when they narrow volatility decreases.

Trend reversals usually take place close to the upper and lower bands and the centre line will sometimes act as support and resistance (Rem: It’s a 20-day SMA). Many traders use these bollinger bands to determine overbought and oversold levels; especially in range bound markets that are said to take place 80% of the time. Price tends to rebound between the upper and lower bands like a drunk bouncing along two alley walls. Bollinger bands don’t produce signals in themselves, but can act as confirmation that reversal is taking place. As we’ll discover below in “Trading overbought and oversold” very often price will “walk” the band, especially in trending markets. Traders use Bollinger bands in a few ways:
  • Identify overbought and oversold 
  • Bollinger Band Contraction 
  • Bollinger Band “Bands” 
  • Combining Bollinger bands and time frame analysis
Trading Overbought and Oversold Levels

Traders use Bollinger bands to identify overbought and oversold levels. When the price of the market touches the upper or lower band the market may be oversold or overbought. If the price crosses the outer Bollinger then this represents significant overbought and oversold. These “tags” and bollinger band crosses are not signals, merely gauges. Prices tend to hug the outer Bollinger for long periods of time, especially in a trend, so other indicators must be used when using them in trading strategies – This is especially true with Bollinger bands over other indicators.

Trading oversold and overbought levels with Bollinger bands is a good strategy in range bound markets, while using other indicators and chat patterns as confirmation (e.g. may be a head and shoulders touching the bollinger). To illustrate this we’ve drawn a chart of S&P 500 that has a range on the right from Mar 2011 and an upward trend on the left. You can see that in the range bound market we have multiple touches of the outer bands and in the up trend the price hugs the upper band for much of the time. Combining the bollinger with another indicator like the RSI helps us with our trading strategy – utilising RSI overbought and oversold signals, RSI trend ID, RSI Divergence/Convergence, Centre Line crossover or RSI failure swings. 

1st Range Trade

In the chart below we have many overbought and oversold levels. Many of them in conjunction with Bollinger would have been profitable. We have an RSI Divergence at (1), which we can look to for possible reversal. Our short/sell signal occurs when the diverged RSI crosses back over the 70-signal line on the 4th May and our exit signal could be when the price hits the opposite bollinger on the 17th May. In range bound markets traders may anticipate that the price will move from one outer band to the other. 

2nd Range Trade

Combing the Bollinger's upper touch with a simple RSI overbought signal at (2) could have been a short trade position. As the RSI crosses 70 it signals a sell/short trade. Our profit target was the lower Bollinger band, but we can't see if it was reached. However, other profit targets can be set. For instance, a trailing stop order could have worked here (trailing price down, until price turns), or our target could have been the oversold RSI 30-level. There are many money management strategies employed by traders, we'll talk about these in future modules.  A Stop/Loss order here would have also been extremely useful, as they limit our losses. When dealing with bollinger bands stop/losses you may want to look at “Bollinger Band “Bands”” below. 

S%P 500 - Bollinger Band Overbought and Oversold

Of course there are many trading signals that can be utilised. After the RSI overbought signals above traders may wait until a 20-day SMA has been crossed before confirming a trade, or a 50-line RSI cross may be needed for confirmation. It's up to you to decide how much confirmation you need prior to trading. More confirmation means less false signals, but also means less profits if the trade goes your way.

Notice the strong trend on the left hand side of the S&P chart above. In a strong trend the price generally fluctuates between the 20-day SMA and an outer band, so a cross of this 20-day SMA may represent a price reversal. This looks to have happened on the 22nd Feb above. A shock has broken 20-period SMA, breaking the trend.

Trading The Bollinger Band Contraction, or “Squeeze”

Generally, after periods of low volatility in the market the market tends to rally significantly. As we’ve learned in chart patterns, when the bulls and bears cancel each other out volume and interest begins to wane. When a break does come, it comes significantly. A contracting bollinger band “the squeeze”, represents low volatility and high volatility widens the bands

LIME - Bollinger Band Volatility with Bandwidth Indicator

In the above chart we have a contraction in the bollinger band up to 7 Jan 11 then a bullish break, from 4.25 resistance, meaning the buyers have won in this situation. We can see the contraction more easily by adding the Bollinger Bandwidth indicator to the bottom of the chart setting it up to 20 periods and 2 SD like the bollinger. To determine the direction of break we need to employ other indicators, like RSI, Stochastics and volume indicators – where we may be looking for divergences. However, this is a challenging play to make…

Bollinger Band "Bands"

Bollinger bands “bands” were created to form buy and sell signals within the bollinger band indicator. Basically the bollinger band “band” measures 2 bollinger bands – The first with a 2 standard deviation (as normal) and the second with a 1 SD, which sits within the 2SD Bollinger band. I’ve illustrated this on the below EUR/USD chart. Basically the chart shows EUR/USD in an up trend until May 11, then in a range - notice the hugging in the up trend. To amend the bollinger band “band” you must edit it in your charting software, by changing the standard deviation to 1 – this creates the inner band. By doing this we’ve created buy & sell and neutral zone.

EUR/USD - Bollinger Band "Bands"

The Bollinger Band “Bands” can be utilised by traders who trade the trend and those who range trade. Trend traders who can enter on oversold oscillator signals like RSI, Williams %R etc can use the buy/sell zone to establish exit points. An up trend trader's exit point could be as the price crosses back below the 20-period SMA centre line, or when price crosses from the buy/sell zone into the 1 SD Bollinger band. The red circles in the above chart highlight some exit positions.  You’ll see that there are many of these exit points in a trend, so traders need to use other indicators to form their exit strategy.

Bollinger Band “Bands” can be used in range trading too. In our EUR/USD chart we’ve highlighted two possible short entry positions with a green circle on the 5th May, confirmed with an oversold RSI 70 crossover (also circled). A cross from the buy/sell zone through the 1 SD Bollinger signals a buy or short trade - in this case a short. This is perhaps not the best example, as initially the trade is against the trend and ideally traders need to confirm the trend has ended (i.e support broken).  However, it does show a trade at work.  An exit for this trade can be played as in the above paragraph - exiting as the price crosses from the bottom buy/sell zone back across to the neutral zone.  I've yellow circled this range exit position.

Bollinger bands can be utilised to form stop/loss decisions. You can either have your stop loss placed just outside the Bollinger band as per position 1 on our chart, or by measuring the bollinger 1st Standard Deviation band height and measuring the same distance up from the top of the 2 SD band (position 2 on our chart above). This prevents us from getting stopped out on market noise. This may be too risky for some though and it all depends on your own trading strategy. We’ll talk about stop/loss and money management in Module 7. 

Combining Bollinger Bands and Adjusting Them 

Bollinger recommended making small incremental adjustments to Standard deviation multiplier if you are looking at different timeframes and sensitivities. If we are looking more long term we may use a 50-day SMA bollinger with standard deviation of 2.1; or short term 10-day SMA with 1.9 SD. He also advocates using Bollinger bands over differing time frames, finding correlation and trading on these correlation signals.

To Sum Up

Bollinger Bands is not an indicator that churns out signals, but as it's based on Moving Averages it can be used to gauge support and resistance as well as volatility.  It is therefore highly recommended to utilise other indicators when using Bollinger band to form trading decisions.

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.


=======

Introduction

In the 1980’s John Bollinger developed his bollinger band theory around moving averages. Bollinger Bands allow us to determine volatility in the market as well as measuring how high/low prices are relative to their historical price action. Bollinger bands comprise of an upper, lower and centre band. The centre line in the band is a simple moving average (SMA) usually set at 20 periods and the upper/lower bands represent chart points that are 2 standard deviations away from the average. Price should normally fall within the upper and lower bands. When the bands widen, volatility increases and when they narrow volatility decreases.

Trend reversals usually take place close to the upper and lower bands and the centre line will sometimes act as support and resistance (Rem: It’s a 20-day SMA). Many traders use these bollinger bands to determine overbought and oversold levels; especially in range bound markets that are said to take place 80% of the time. Price tends to rebound between the upper and lower bands like a drunk bouncing along two alley walls. Bollinger bands don’t produce signals in themselves, but can act as confirmation that reversal is taking place. As we’ll discover below in “Trading overbought and oversold” very often price will “walk” the band, especially in trending markets. Traders use Bollinger bands in a few ways:
  • Identify overbought and oversold 
  • Bollinger Band Contraction 
  • Bollinger Band “Bands” 
  • Combining Bollinger bands and time frame analysis
Trading Overbought and Oversold Levels

Traders use Bollinger bands to identify overbought and oversold levels. When the price of the market touches the upper or lower band the market may be oversold or overbought. If the price crosses the outer Bollinger then this represents significant overbought and oversold. These “tags” and bollinger band crosses are not signals, merely gauges. Prices tend to hug the outer Bollinger for long periods of time, especially in a trend, so other indicators must be used when using them in trading strategies – This is especially true with Bollinger bands over other indicators.

Trading oversold and overbought levels with Bollinger bands is a good strategy in range bound markets, while using other indicators and chat patterns as confirmation (e.g. may be a head and shoulders touching the bollinger). To illustrate this we’ve drawn a chart of S&P 500 that has a range on the right from Mar 2011 and an upward trend on the left. You can see that in the range bound market we have multiple touches of the outer bands and in the up trend the price hugs the upper band for much of the time. Combining the bollinger with another indicator like the RSI helps us with our trading strategy – utilising RSI overbought and oversold signals, RSI trend ID, RSI Divergence/Convergence, Centre Line crossover or RSI failure swings. 

1st Range Trade

In the chart below we have many overbought and oversold levels. Many of them in conjunction with Bollinger would have been profitable. We have an RSI Divergence at (1), which we can look to for possible reversal. Our short/sell signal occurs when the diverged RSI crosses back over the 70-signal line on the 4th May and our exit signal could be when the price hits the opposite bollinger on the 17th May. In range bound markets traders may anticipate that the price will move from one outer band to the other. 

2nd Range Trade

Combing the Bollinger's upper touch with a simple RSI overbought signal at (2) could have been a short trade position. As the RSI crosses 70 it signals a sell/short trade. Our profit target was the lower Bollinger band, but we can't see if it was reached. However, other profit targets can be set. For instance, a trailing stop order could have worked here (trailing price down, until price turns), or our target could have been the oversold RSI 30-level. There are many money management strategies employed by traders, we'll talk about these in future modules.  A Stop/Loss order here would have also been extremely useful, as they limit our losses. When dealing with bollinger bands stop/losses you may want to look at “Bollinger Band “Bands”” below. 

S%P 500 - Bollinger Band Overbought and Oversold

Of course there are many trading signals that can be utilised. After the RSI overbought signals above traders may wait until a 20-day SMA has been crossed before confirming a trade, or a 50-line RSI cross may be needed for confirmation. It's up to you to decide how much confirmation you need prior to trading. More confirmation means less false signals, but also means less profits if the trade goes your way.

Notice the strong trend on the left hand side of the S&P chart above. In a strong trend the price generally fluctuates between the 20-day SMA and an outer band, so a cross of this 20-day SMA may represent a price reversal. This looks to have happened on the 22nd Feb above. A shock has broken 20-period SMA, breaking the trend.

Trading The Bollinger Band Contraction, or “Squeeze”

Generally, after periods of low volatility in the market the market tends to rally significantly. As we’ve learned in chart patterns, when the bulls and bears cancel each other out volume and interest begins to wane. When a break does come, it comes significantly. A contracting bollinger band “the squeeze”, represents low volatility and high volatility widens the bands

LIME - Bollinger Band Volatility with Bandwidth Indicator

In the above chart we have a contraction in the bollinger band up to 7 Jan 11 then a bullish break, from 4.25 resistance, meaning the buyers have won in this situation. We can see the contraction more easily by adding the Bollinger Bandwidth indicator to the bottom of the chart setting it up to 20 periods and 2 SD like the bollinger. To determine the direction of break we need to employ other indicators, like RSI, Stochastics and volume indicators – where we may be looking for divergences. However, this is a challenging play to make…

Bollinger Band "Bands"

Bollinger bands “bands” were created to form buy and sell signals within the bollinger band indicator. Basically the bollinger band “band” measures 2 bollinger bands – The first with a 2 standard deviation (as normal) and the second with a 1 SD, which sits within the 2SD Bollinger band. I’ve illustrated this on the below EUR/USD chart. Basically the chart shows EUR/USD in an up trend until May 11, then in a range - notice the hugging in the up trend. To amend the bollinger band “band” you must edit it in your charting software, by changing the standard deviation to 1 – this creates the inner band. By doing this we’ve created buy & sell and neutral zone.

EUR/USD - Bollinger Band "Bands"

The Bollinger Band “Bands” can be utilised by traders who trade the trend and those who range trade. Trend traders who can enter on oversold oscillator signals like RSI, Williams %R etc can use the buy/sell zone to establish exit points. An up trend trader's exit point could be as the price crosses back below the 20-period SMA centre line, or when price crosses from the buy/sell zone into the 1 SD Bollinger band. The red circles in the above chart highlight some exit positions.  You’ll see that there are many of these exit points in a trend, so traders need to use other indicators to form their exit strategy.

Bollinger Band “Bands” can be used in range trading too. In our EUR/USD chart we’ve highlighted two possible short entry positions with a green circle on the 5th May, confirmed with an oversold RSI 70 crossover (also circled). A cross from the buy/sell zone through the 1 SD Bollinger signals a buy or short trade - in this case a short. This is perhaps not the best example, as initially the trade is against the trend and ideally traders need to confirm the trend has ended (i.e support broken).  However, it does show a trade at work.  An exit for this trade can be played as in the above paragraph - exiting as the price crosses from the bottom buy/sell zone back across to the neutral zone.  I've yellow circled this range exit position.

Bollinger bands can be utilised to form stop/loss decisions. You can either have your stop loss placed just outside the Bollinger band as per position 1 on our chart, or by measuring the bollinger 1st Standard Deviation band height and measuring the same distance up from the top of the 2 SD band (position 2 on our chart above). This prevents us from getting stopped out on market noise. This may be too risky for some though and it all depends on your own trading strategy. We’ll talk about stop/loss and money management in Module 7. 

Combining Bollinger Bands and Adjusting Them 

Bollinger recommended making small incremental adjustments to Standard deviation multiplier if you are looking at different timeframes and sensitivities. If we are looking more long term we may use a 50-day SMA bollinger with standard deviation of 2.1; or short term 10-day SMA with 1.9 SD. He also advocates using Bollinger bands over differing time frames, finding correlation and trading on these correlation signals.

To Sum Up

Bollinger Bands is not an indicator that churns out signals, but as it's based on Moving Averages it can be used to gauge support and resistance as well as volatility.  It is therefore highly recommended to utilise other indicators when using Bollinger band to form trading decisions.

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.


>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments