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Bollinger Bands Indicator Tutorial

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BOLLINGER BANDS INTRODUCTION,TUTORIAL AND GUIDE:

Bollinger Bands are applied directly to price charts, providing a gauge for how strong a trend is, and spotting potential bottoms and tops in stocks prices. Band width fluctuates based on volatility; the ability for Bands to adapt to changing market conditions makes it a popular indicator amongst traders. To use Bollinger Bands effectively, we must understand how they work, their trading applications, and pitfalls.

WHAT ARE THE BOLLINGER BANDS?

Bollinger Bands® are a volatility based indicator, developed by John Bollinger, which have a number of trading applications.

There are three lines that compose Bollinger Bands: A simple moving average (middle band) and an upper and lower band. These bands move with the price, widening or narrowing as volatility increases or decreases, respectively. The position of the bands and how the price acts in relation to the bands provides information about how strong the trend is and potential bottom or topping signals.

Bollinger Bands are used on all timeframes, such as daily, hourly or five-minute charts. Bollinger Bands have two adjustable settings: the Period and the Standard Deviation. The Period is how many price bars are included in the Bollinger Band calculation. The number of periods used is often 20, but is adjusted to suit various trading styles.

The Standard Deviation is typically set at 2.0, and determines the widths of the Bands. The higher the Standard Deviation, the harder it will be for the price to reach the upper or lower band. The lower the Standard Deviation the easier it is for price to “breakout” of the Bands.

Bollinger Bands denoted (20,2) means the Period and Standard Deviation are set to 20 and 2, respectively.

The indicator is calculated using the following formula. First calculate the Middle Band, then calculate the Upper and Lower Bands.

Middle Band = 20-day simple moving average (SMA).
Upper Band = 20-day SMA + (20-day standard deviation of price x 2).
Lower Band = 20-day SMA – (20-day standard deviation of price x 2).
Where SMA = the sum of closing prices over n periods / by n.

Figure 1 shows how Bollinger Bands looks on a chart as they move and adapt with price.

22 Bollinger Band Rules

Bollinger Bands provide a relative definition of high and low. By definition price is high at the upper band and low at the lower band.

That relative definition can be used to compare price action and indicator action to arrive at rigorous buy and sell decisions.
Appropriate indicators can be derived from momentum, volume, sentiment, open interest, inter-market data, etc.
If more than one indicator is used the indicators should not be directly related to one another. For example, a momentum indicator might complement a volume indicator successfully, but two momentum indicators aren’t better than one.
Bollinger Bands can be used in pattern recognition to define/clarify pure price patterns such as “M” tops and “W” bottoms, momentum shifts, etc.
Tags of the bands are just that, tags not signals. A tag of the upper Bollinger Band is NOT in-and-of-itself a sell signal. A tag of the lower Bollinger Band is NOT in-and-of-itself a buy signal.
In trending markets price can, and does, walk up the upper Bollinger Band and down the lower Bollinger Band.
Closes outside the Bollinger Bands are initially continuation signals, not reversal signals. (This has been the basis for many succeuful volatility
breakout systems.)

The default parameters of 20 periods for the moving average and standard deviation calculations, and two standard deviations for the width of the bands are just that, defaults. The actual parameters needed for any given market/task may be different.
The average deployed as the middle Bollinger Band should not be the best one for crossovers. Rather, it should be descriptive of the intermediate-term trend.
For consistent price containment: If the average is lengthened the number of standard deviations needs. to be increased; from 2 at 20 periods, to 2.1 at 50 periods. Likewise, if the average is shortened number of standard deviations should be reduced; from 2 at 20 periods, to 1.9 at 10 periods.
Traditional Bollinger Bands are based upon a simple moving average. This is because a simple average is used in the standard deviation calculation and we wish to be logically consistent.
Exponential Bollinger Bands eliminate sudden changes in the width of the bands caused by large price changes exiting the back of the calculation window. Exponential averages must be used for BOTH the middle band and in the calculation of standard deviation.
Make no statistical assumptions based on the use of the standard deviation calculatio in the construction of the bands. The distribution of security prices is non-normal and the typical sample size is most deplyments of Bollinger Bands is too small for statistical significance. (In practice we typically find 90%, not 95%, of the data inside Bollinger Bands with the default parameters)
%b tells us where we are in relation to the Bollinger Bands. The position within the bands is calculated using an adaptation of the formula for Stochastics .
%b has many uses; among the more important are identification of divergences, pattern recognition and the coding of trading systems using Bollinger Bands.
Indicators can be normalized with %b, eliminating fixed thresholds in the process. To do this plot 50- period or longer Bollinger Bands on an indicator and then calculate %b of the indicator.
BandWidth tells us how wide the Bollinger Bands are. The raw width is normalized using the middle band. Using the default parameters BandWidth is four times the coefficient of variation.
BandWidth has many uses. Its most popular use is to indentify ‘The Squeeze., but is also useful in identifying trend changes…
Bollinger Bands can be used on most financial time series, including equities, indices, foreign exchange, commodities, futures, options and bonds.
Bollinger Bands can be used on bars of any length, 5 minutes, one hour, daily, weekly, etc. The key is that the bars must contain enough activity to give a robust picture of the price-formation mechanism at work.
Bollinger Bands do not provide continuous advice; rather they help indentify setups where the odds may be in your favor.

A note from John Bollinger:

One of the great joys of having invented an analytical technique such as Bollinger Bands is seeing what other people do with it. These rules covering

the use of Bollinger Bands were assembled in response to questions often asked by users and our experience over 25 years of using the bands. While there

are many ways to use Bollinger Bands, these rules should serve as a good beginning point.

FINDING TOPS AND BOTTOMS WITH BOLLINGER BANDS

After setting your Bollinger Bands to 2.5 standard deviations, you will see that price reaches the outer bands less often. At the same time, the meaning of such signals becomes much more important because it shows significant price extremes.

We highly recommend combining the Bollinger Bands with the RSI indicator – it’s the perfect match. There are two types of tops that you need to know about:

1) Price spikes into the outer Bollinger Bands which get rejected immediately >> Reversal signal.

2) After a trend move, price fails to reach the outer Band as the trend becomes weaker. This signal is usually accompanied by an RSI divergence >> Continuation signal.

The screenshot below shows both scenarios: the first is the market top after a divergence – see how the trend became weaker and lost momentum and then eventually failed to reach the outer Band before reversing. I marked the second spike with an arrow – this was a trend continuation signal as price failed to break higher during the downtrend. The strong spike that was followed by a fast rejection showed that bulls lacked power.

A note from John Bollinger:

One of the great joys of having invented an analytical technique such as Bollinger Bands is seeing what other people do with it. These rules covering

the use of Bollinger Bands were assembled in response to questions often asked by users and our experience over 25 years of using the bands. While there

are many ways to use Bollinger Bands, these rules should serve as a good beginning point.

FINDING TOPS AND BOTTOMS WITH BOLLINGER BANDS

After setting your Bollinger Bands to 2.5 standard deviations, you will see that price reaches the outer bands less often. At the same time, the meaning of such signals becomes much more important because it shows significant price extremes.

We highly recommend combining the Bollinger Bands with the RSI indicator – it’s the perfect match. There are two types of tops that you need to know about:

1) Price spikes into the outer Bollinger Bands which get rejected immediately >> Reversal signal.

2) After a trend move, price fails to reach the outer Band as the trend becomes weaker. This signal is usually accompanied by an RSI divergence >> Continuation signal.

The screenshot below shows both scenarios: the first is the market top after a divergence – see how the trend became weaker and lost momentum and then eventually failed to reach the outer Band before reversing. I marked the second spike with an arrow – this was a trend continuation signal as price failed to break higher during the downtrend. The strong spike that was followed by a fast rejection showed that bulls lacked power.

TREND-TRADING WITH THE BOLLINGER BANDS

In contrast to most other indicators, the Bollinger Bands are non-static indicators and they change their shape based on recent price action and accurately measure momentum and volatility. Thus, we can use the Bollinger Bands to analyze the strength of trends and get a lot of important information this way. There are just a few things you need to pay attention to when it comes to using Bollinger Bands to analyze trend strength:

During strong trends, price stays close to the outer band.
If price pulls away from the outer band as the trend continues, it shows fading momentum.
Repeated pushes into the outer bands that don’t actually reach the band show a lack of power.
A break of the moving average is often the signal that a trend is ending.
The screenshot below shows how much information a trader can pull from using Bollinger Bands alone. Let me walk you through the points 1 to 5:

1) Price is in a strong downtrend and price stays close to the outer bands all the time – very bearish signal.

2) Price fails to reach the outer band and then shots up very strongly, even showing an engulfing pattern. This is a classic reversal pattern where the bearish trend strength faded.

3) 3 swing highs with lower highs. The first swing high reached the outer band whereas the following two failed – fading strength.

4) A strong downtrend where price stayed close to the outer band. It tried to pull away, but bears were always in control.

5) Price consolidates sideways, not reaching the outer band anymore and the rejection-pinbar ended the downtrend.

As you can see, the Bollinger Bands alone can provide a lot of information about trend strength and the balance between bulls and bears.

THE ROLE OF THE MOVING AVERAGE

During trends, the moving average holds very accurately and a break of that moving average is usually a meaningful signal that the sentiment has shifted. The screenshot below shows nicely how price trended between the outer bands and the moving average both on the way up and down. During the trend, the moving average could have been used as a re-entry signal to add to existing positions during pullbacks.

Furthermore, the moving average can be used as a trade exit signal where a trader does not close his existing positions unless price has broken the moving average. By combining the Bollinger Bands with the moving average, a trader can already create a robust trading method.

You can see, the Bollinger Bands are a multi-faceted trading indicator that can provide you with lots information about trend, buy/seller balances and about potential trend shifts. Together with the moving average and the RSI, Bollinger Bands make for a great foundation for a trading strategy.

BOLLINGER BANDS STRATEGIES

DOUBLE TOP FORMATION:

The M pattern is commonly known as the double top, using a Bollinger band strategy can add more meaning to this term in practice.

When prices are repelled by the top band twice it can mean that the market has run out of steam and a race to the bottom band could occur, these instances are a feature of volatility within the market.

In the above chart, prices were repelled twice, and then pushed down to the bottom band.

This double top also marked the beginning of a downtrend.

In this Bollinger bands strategy, you should look for three things to happen to pick out a double top formation and confirm the pattern.

Firstly the price puts in a reaction high to the upper band.
Next a pullback to the simple moving average.
Then price moves back to the first high but will fail at or below the upper band.
The waning momentum causes the failure of the second high, we can then look for confirmation of the top with a break of support and I like to see two candles close whose real bodies are below the MA line.

Double bottom formation:

The opposite will also occur regularly at significant lows.

Where prices drop to the bottom band twice in short order and then are repelled upwards, beginning an uptrend in the market.

In the chart above two W patterns formed in the uptrend, adding weight to the trend and signifying that a trader should stick with the trend.

There is a four step process in this Bollinger bands strategy to confirm a W bottom is in place.

Firstly a low forms, usually below the lower band.
next a retracement to the middle band.
then a new low forms but will hold on or above the lower band showing a slowing of downside momentum.
And lastly, the pattern is confirmed when the price rallies to the upper band and completes two candles whose real bodies are above the middle band.
A trader should always wait until all of the four steps are complete before trading the move. this will reduce false signals and spare your capital in the long run.

I will commonly use a stop loss order to trade this setup, using the higher ‘price low’ of the formation as the stop loss position.

Bollinger band squeeze:

The Bollinger band squeeze happens when price movements contract to a narrow range.

This causes the Bollinger bands to move inwards towards each other.

It is almost like a pressure is building within the market and it will lead to a sharp movement in prices sooner rather than later.

In the example above, a squeeze always occurred before any significant move in prices.

It is a valuable indication of the possibility of volatility ahead.

So a trader will always be aware of the position and trend in the Bollinger bands. And if you notice the Bollinger bands ‘squeeze’ together, you can start to position yourself because a significant price movement is straight ahead.

How does it work?

When trading using this Bollinger bands strategy, we are looking for contraction in the bands. Above is the EURCHF 60 minute chart lets see what sort of signals are generated from it.

The chart above shows 20 point increments in EUR/CHF, every time the Bollinger band width is approaching 0.0010 or about 10 points, we get an average move away from the moving average of about 40 points sometimes more.

In the above case, a trader could use the squeeze as a signal generator, a signal is generated when:

the bands squeeze to within about 10 points
and a full candle completes above or below the moving average line.
depending on which side the candle completes that is the side you trade.

So, if a candle completes above the MA, then you go long, and if a candle completes below you go short. your stops should be placed at the opposite extreme of the candle.

BOLLINGER BANDS AS SUPPORT AND RESISTANCE:

Along with giving the trader an indication of future volatility ahead, this Bollinger bands strategy will show support and resistance in a trending market, often repelling prices back into the trend once more.

In both the downward trend and the upward trend i the chart above, the bands acted as consolidation points.

The fact that prices were repelled by the bands showed the trader that they could stick with the trend.

RIDING THE BANDS:

Another Bollinger bands strategy is riding the bands, this is when we use the bands as a trend recognition tool.

During strong trend moves, the candles tend to almost stick to the upper or lower band.

This occurrence shows the trader that the trend is likely to continue and has power behind it.

John Bollinger, the bands creator, calls a move that touch the bands a ‘tag’ of the band. this is not exactly a signal but it does denote a strengthening or weakening market.

Take note for a second;

the bands are placed 2 standard deviations away from the 20 period simple moving average on both sides. So the bands contain 95.6% of all the price moves in the last 20 periods.

If the price tags the upper or lower band, it shows us that there is significance in that move. Because it is more powerful than 95.6% of all the moves in the last 20 periods.

IF a powerful move occurs, it can be common for the simple moving average to act as support for the price. The price will usually stay above or below the SMA in a trend move. This knowledge can be used in managing your position when you are trend trading.

THINGS TO TAKE AWAY:

When used alone the bands offer little in the way of timing or trade entry indicators.

But,

The Bollinger bands do give the trader a useful benchmark to judge how the price action is likely to act given certain action.
They can be a great tool to measure volatility, or lack thereof, in the market.
And they can show you where likely support and resistance might occur within a trend.
Bollinger band strategy uses these phenomena to trade trend moves within a market
These points alone are evidence enough that we all should take heed of the bands!

Forex and Some Important Facts about Bollinger Bands.

Forex trading is nowadays one of the most looked after occupation for many persons of all ages around the world. This is due to its great advantages over other capital markets and its high profitability potential; among these advantages you will find that is extremely easy to access a trading platform from the best forex broker firms thanks to the internet; and also you will notice that Forex has a high liquidity along with a high leverage.

But having a good broker firm and great trading platform is only one part of what you need in order to make your forex trading career a winning and profitable one. You need to have the right knowledge and techniques in order to forecast with the best accuracy what the market will do next. One of the techniques used to predict the Forex market behavior is that based on Bollinger Bands.

These Bollinger Bands are what is called a technical trading tool and they are widely used in the capital markets (including Forex) and were created by John Bollinger in the early 1980s. These bands technique was formulated based on the need for adaptive trading bands and the discovery that the volatility of the markets was a dynamic phenomena, not a static one as was widely believed at the time.

Bollinger Bands consist of a chart of three curves drawn in relation to currency pairs prices. The band situated in the middle is a measure of the intermediate-term trend and is usually a simple moving average, that serves as the base for the upper and lower bands. The interval between the upper, lower and the middle bands is determined by the volatility of the market, typically the standard deviation of the same data that were used for the moving average. The default parameter is 20 periods and two standard deviations above and below the middle band; of course this may be adjusted to suit your needs.

In short, the purpose of Bollinger Bands is to provide a relative definition of high and low price. By definition prices are considered high when touching the upper band and low when they touch the lower band. This relative definition can be used by the Forex trader to compare price actions and as a very useful indicator when the purpose of the trader is to arrive at rigorous buy and sell decisions.

Sources https://en.wikipedia.org/
https://vladimirribakov.com/

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