All About Using Bollinger Bands!

Bollinger bands is a technical analysis tool created in the 1980s by John Bollinger. This indicator was developed to help traders observe the volatility of price over a period of time.

It consists of 3 bands:

• The middle band known as the Simple Moving Average (measures the intermediate-trend)

• An upper-band (usually 2 standard deviation above the middle band)

• A lower-band (2 standard deviation below the middle band)

The default setting for is 20 for period and 2 for deviation. It provides you with an insight that price are high at the upper band and low at the lower band.

This system of trading is famous among traders. They give an indication of when to buy or sell a particular currency. You may want to buy when price touches the lower bands and exit when price retraces back to the middle band. Same rule applies for selling that is, sell when price touches the upper band and exit when it reaches the middle band. To make it simpler, they may be used as support and resistance levels.

As a side note, the formula used in the calculation of Bollinger bands is as follows:

Upper Band = MA (TP, n) + m * SD[TP, n]
Lower Band = MA (TP, n) - m * SD[TP, n]
SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3
n = Smoothing Period
m = Number of Standard Deviations (SD)

Now pull a daily chart and add the Bollinger band onto it and observe how price reacts when it reaches the upper of lower bands.

See the below screenshot:

Though this type of trading is common among traders, John Bollinger says that price touching the upper band is not in and of itself a sell signal. On the other hand price touching the lower Bollinger band is not in and of itself a buy signal. Price does happen to break those bands and trade higher or lower. Thus, traders who try to "sell the top" or "buy the bottom" are often wiped out from the market.

The appropriate way of using the this tool is to use it to determine the trend. The whole purpose of this indicator is to measure deviation thus making it a useful tool in determining trend. You may add an oscillator to support your buying and selling signals. Stochastic oscillator would be a good choice with settings (11, 3, 3) to capture the right signals.

Example shown below:

When stochastic oscillator points up with both lines above 20 or just crossed 20 from below and price is above middle band on chart, it’s your signal to buy.

The use of an oscillator eliminates the false signals when the bands defines the trend. Important point to note that this system is not 100% accurate, no system is. But it does eliminate false signals to a certain degree.

To your success...

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