Bollinger Bands: Four Basic Trading Strategies

Bollinger Bands: Four Basic Trading Strategies

The Bollinger Bands have been widely used in financial trading for a long time. These bands are extensively used because they have the capability to give data for various situations and markets. The bands were commonly used in stock trading and commodity trading. Nowadays though, they can be used in virtually any financial market including the forex market. The Bollinger strategy was developed in the 1980s. This financial analyst came up with the strategy after noticing a deficiency in some of the other tools that were used in the market. Being one of the most recently invented financial trading tools, the bands represent the evolution of financial analysis. There are several principles that come alongside the bands to govern how they are used. In order to trade effectively with Bollinger Bands, you need to understand the four basic strategies associated with them.

The Structure of the Bollinger Bands

Before learning about the strategies associated with the bands, it is important to understand how they look and how they work. Basically, a complete Bollinger Bands indicator has:

  • The top and bottom bands (outer bands)
  • The middle band
  • The space between the bands

Each of the above elements is important in indicating particular situations in the market. The middle band serves as the main line which is a computed moving average of the price. The upper and lower bands are basically a deviation of the middle band. They represent the market extremes. Finally, the space between the bands indicates volatility. Since the outer bands are computed as standard deviations, changes in the bandwidth can indicate varying levels of volatility. Bollinger Bands are not difficult to understand, in fact, the Admiral Markets guide can give you a full account of everything you need to know about trading with the bands.

How You Can Utilize Bollinger Bands Strategies When Trading

1. To follow the trends

You can use the bands to observe the market trends and what they signal. Both the middle line and the outer lines indicate breakout moments in the market. This happens when there is a crossover between the lines. When the cross happens upwards, the market is considered to be bullish. A downward cross, on the other hand, indicates the opposite signal. If the bandwidth is big, then it means that the crossover is taking place in a volatile market. Converging bands alternatively show that the market’s volatility is low. Since the bands are able to accurately depict the trends, a trader can use the signals to trade appropriately.

2. To detect price extremes

Bollinger Bands are also excellent for indicating situations where the asset under observation in the market is on a high demand or low demand. This is done by indicating whether the asset is oversold or overbought. The outer bands are responsible for indicating these two situations based on their deviation from the main center line. Greater standard deviation usually indicates an extreme price movement. The bands can be used to derive insights for both the long-term and short-term periods. In the short-term, the signals indicate overbought/oversold situations while in the long-term, they indicate bearish/bullish situations.

3. To show volatility breakouts

Breakouts are very common in financial markets. Breakouts are situations where the volatility in the market abruptly changes from low to high. The volatility comes about as a reaction to the price in the assets. The price is, in turn, a reflection of a change in demand in the market. Breakouts usually happen when an important headline is expected in the market. At such moments traders are not engaging in any activity as they anticipate the news before they make appropriate trade moves.

4. For contrarian investing

It is not always when traders buy or sell in accordance with conventional standards. Sometimes, some investors see it fit to invest against the normal signals since they are expecting that the rest of the market is going to invest in that direction. For such a contrarian strategy, therefore, the Bollinger Bands provide the best signals. Contrarian investors observe the pro-investment signals provided by the bands and choose to invest in contrary to the signals.

In Summary

Bollinger Bands are great for providing an authentic view of the market situation. Since they are versatile, the bands can be used for a wide range of trading strategies which are listed above.