Among the numerous technical indicators available, Bollinger Bands are one of the most popular.
They are a useful and powerful tool for analysing market volatility, identifying trends, and spotting potential trade entry points.
In this comprehensive guide, we’ll explore everything you need to know about Bollinger Bands, from their origins and calculation, to practical tips and advanced strategies for using them.
What are Bollinger Bands?
Bollinger bands are named after their creator, John Bollinger, a renowned technical analyst who introduced them to the trading world in 1983.
They are now widely-used in all forms of trading as a reliable indicator which highlights the volatility of an asset.
They consist of three lines plotted on a price chart. The upper and lower bands are calculated based on volatility, specifically the standard deviation of price movement.
They are positioned a certain number of standard deviations away from the middle band.
Together, these bands identify potential overbought or oversold conditions in the market, and also signal potential trend reversals.
For this reason, they are extensively used by traders to give trade entry and exit signals.
What do Bollinger Bands look like?
This is what Bollinger Bands look like:
As you can see, the bands consist of three lines:
- a middle line, which is a simple moving average (SMA)
- upper and lower lines, that are positioned a certain number of standard deviations away from the SMA. (The default is two standard deviations.)
The space between these upper and lower lines is the band itself, and is often shown in a different colour on trading charts, such as the blue band that TradingView uses.
The bands get narrower as volatility decreases, and they expand, or get wider as volatility increases.
A period of low volatility, with narrow Bollinger Bands:
Contrast this with a period of high volatility, when the Bollinger Bands expand:
What are Bollinger Bands used for?
The primary purpose of Bollinger Bands is to give a visual indication of the volatility of price action.
However, they serve multiple purposes in technical analysis, including:
- measuring volatility
- identifying trends
- acting as dynamic support and resistance levels
- giving trade entry signals
We also use Bollinger Bands to detect potential reversals, breakouts, and trend continuations in the market.
If you’d like further information about trade entry strategies using Bollinger Bands, see The Advanced Course for Forex Traders Lesson 7, Simple Entries for Decisive Trading.
What is standard deviation?
Standard deviation measures how scattered data points are around the average (the mean) of price action:
- a high standard deviation indicates large variations
- a low standard deviation suggests data points are clustered closer to the average
As standard deviation increases (meaning higher volatility), the Bollinger Bands widen, indicating larger price swings.
When standard deviation decreases (lower volatility), the bands contract, signifying a calmer market with smaller price movements.
How are Bollinger Bands calculated?
Bollinger Bands use a simple moving average (SMA) to represent the central price line, and standard deviation to calculate the upper and lower bands.
Forex traders typically use a standard deviation of two, and a 20-period moving average when calculating Bollinger Bands.
However, these parameters can be adjusted to suit different trading styles, market conditions and assets being traded.
While two is the most common standard deviation, using one or three might be more suitable, depending on your trading strategy and risk tolerance.
Lowering the standard deviation to one will bring the Bollinger Bands closer to price action.
Conversely, increasing the deviation to three will move the bands further away from price action.
This is an example of the Bollinger Bands deviation set to 1, rather than the standard two deviations. See how much closer the bands are to price action?
How Bollinger Bands indicate overbought and oversold conditions
When set at the default standard deviation of two, the upper band acts as a resistance level.
Price action above the top band suggests prices might be overbought and due for a pullback.
Here’s what it looks like when price action breaks above the top Bollinger Band, signifying overbought price conditions:
Conversely, the lower band acts as a support level.
Price action below this line implies the asset might be oversold, and ready for a bounce back up, as in this example:
See how after the red candlesticks break below the lower Bollinger Band, that price action then moves back up towards the centre band again?
How to use Bollinger Bands
There are two popular Bollinger Band trading strategies that are simple for beginner traders to use. They are:
- The Bollinger Band Squeeze
- The Bollinger Band Bounce
The Squeeze
One of the most popular trading strategies involving Bollinger Bands is the Bollinger Band Squeeze.
This strategy capitalises on periods of low volatility, characterised by the bands contracting close to each other.
The theory behind the Bollinger Band Squeeze is that after a period of low volatility (contracting bands), a breakout is likely to occur, with the price potentially moving sharply in either direction.
This is based on the observation that prices tend to revert to the mean (middle line) after deviating significantly.
Traders wait for a breakout or breakdown from the squeeze, signalling a potential sharp price move.
In the example below, there is a breakdown following a period of low volatility when the Bollinger Bands contract.
The Bounce
Another common strategy is the Bollinger Band Bounce, which exploits the tendency of prices to revert to the middle band after reaching the outer bands.
The bounce idea assumes that prices are unlikely to sustain a move outside the Bollinger Bands for a long period of time.
A touch or penetration of the Bollinger Bands, followed by a reversal, suggests a potential return towards the middle line.
We enter a trade when the price touches or penetrates the outer bands, anticipating a reversal towards the middle band.
- A buy signal for a long trade is generated when the price touches or falls below the lower Bollinger Band, and then starts to reverse direction, potentially bouncing back upwards.
A Bollinger Band ‘bounce up’ after price action broke below the lower Bollinger Band
Conversely, a sell signal for a short trade is generated when the price touches or rises above the upper Bollinger Band, and then starts to move back down.
A Bollinger Band ‘bounce down’ after price action broke above the upper Bollinger Band.
Combining the Squeeze and Bounce
The Bollinger Band Squeeze and Bounce strategy looks for a combination of these two concepts.
Identify a Bollinger Band Squeeze, then look for a price touch or penetration of either the upper or lower Bollinger Band.
Then, a bounce in the opposite direction will be your entry signal.
For example, look at the Bollinger Bands narrowing above, as volatility reduces.
It is followed by an upward bounce or breakout that penetrates above the top Bollinger Band.
The red candlestick at the top of the bounce represents a trend reversal, which could signal an entry for a short trade.
This would be a successful short trade over six periods as the Bollinger Bands return to the middle line.
False signals
Like any technical indicator, Bollinger Bands can generate false signals.
Squeezes don’t guarantee a breakout in a particular direction, and price bounces can be short-lived.
Therefore, it’s always worth combining Bollinger Band signals with other indicators, or candlestick patterns, before deciding to enter a trade.
Using Bollinger Bands to define support and resistance
Bollinger Bands act as dynamic support and resistance levels, with the lower band serving as support and the upper band acting as resistance.
Prices are likely to bounce off the lower band when approaching from above, and reverse from the upper band when approaching from below.
The example below shows how Bollinger Bands act as support and resistance levels too.
Can Bollinger Bands be used alone to identify support and resistance levels?
While Bollinger Bands can provide valuable insights into support and resistance levels, they are most effective when used in conjunction with other technical indicators and chart patterns.
You should consider additional factors, such as trendlines and candlestick patterns, to confirm support and resistance levels identified by Bollinger Bands.
Using Bollinger bands to set stop loss levels
In addition to identifying entry and exit points, Bollinger Bands can also help you manage risk effectively.
By placing stop-loss orders below the lower band for long positions, and above the upper band for short positions, you can limit potential losses and protect your capital in case of adverse price movements.
The dynamic nature of Bollinger Bands allows you to adjust your stop-loss levels as prices fluctuate, ensuring that they remain aligned with the evolving market conditions.
The example below shows how Bollinger Bands can be used to identify an effective trailing stop-loss point for a long trade.
Using Bollinger Bands to confirm reversal signals
Bollinger Bands can also be used to confirm reversal signals generated by other technical indicators or chart patterns.
For example, if a candlestick pattern forms near the upper band, accompanied by an overbought signal on the Relative Strength Index (RSI), it could signal a potential uptrend reversal from overbought conditions.
Similarly, if a candlestick reversing pattern forms near the lower Bollinger Band, accompanied by an oversold indicator on the RSI, it could signal a potential reversal from oversold conditions.
By combining Bollinger Bands with other technical tools, you can increase the reliability of your reversal signals and make more informed trading decisions.
Choosing the correct Bollinger Band parameters
The effectiveness of Bollinger Bands depends on the parameters you choose, such as the centre line period and standard deviation multiplier.
You should experiment with different settings and conduct thorough back-testing to identify the optimal parameters for your chosen trading style.
Keep in mind there is no ‘one-size-fits-all’ approach, and what works for one trader may not work for another.
Here are some suggestions about the parameters to use depending on your style of trading:
Scalping:
- Period: 5-10
- Standard Deviation: 0.5-1
Short-term trading:
- Period: 10-20
- Standard Deviation: 1-2
Day trading:
- Period: 20-30
- Standard Deviation: 2-3
Swing trading:
- Period: 50-100
- Standard Deviation: 2-3
Longer –term position trading:
- Period: 100-200
- Standard Deviation: 2-3
Altering Bollinger Band parameters
If you are using TradingView for your charting, you can alter the parameters of the Bollinger Bands by selecting the bands, and then choosing ‘settings.’ You should see a settings box appear, where you can change the parameters of the Bollinger Bands.
Change the period of the bands by altering the ‘Length’ setting, and the deviation by changing the ‘StdDev’ setting.
Final thoughts
In our trading experience, Bollinger Bands offer a versatile and dynamic tool for tracking volatility, identifying support and resistance levels, and finding entry and exit points when trading.
My colleague Sam Eder uses Bollinger Bands extensively in his day-to-day forex trading.
By understanding the principles behind Bollinger Bands, interpreting their signals effectively, and applying some of the entry strategies mentioned above, you too can achieve greater trading success.
If you like this article, then sign up for our newsletter, or join over 42,000 other traders and get The Advanced Forex Course for Smart Traders 2.0. It’s 100 % free.
Till next time,
Frequently asked questions
What time frame is best for using Bollinger Bands?
The best time frame for using Bollinger Bands depends on the trader’s trading style and objectives.
Short-term traders may prefer lower time frames, such as 5-minute or 15-minute charts, to capture intraday price movements.
Long-term investors may focus on higher time frames, such as daily or weekly charts, to identify long-term trends and reversals.
Can Bollinger Bands be used for cryptocurrency trading?
Yes, Bollinger Bands can be used for cryptocurrency trading, just like any other financial instrument.
Cryptocurrency markets exhibit similar patterns of price volatility and trends as traditional markets, making Bollinger Bands a valuable tool for technical analysis.
Traders can apply Bollinger Bands to cryptocurrency charts just as they can be applied to charts of any other financial asset being traded to identify potential trading opportunities.
How can I identify fakeouts with Bollinger Bands?
Fakeouts, or false breakouts, occur when the price briefly penetrates the outer bands of Bollinger Bands, but fails to sustain the momentum, resulting in a reversal back within the bands.
Bollinger Bands alone won’t help you identify fakeouts.
You will need to use additional confirmation signals, such as candlestick patterns and other technical indicators, to filter out fakeouts and avoid entering false trades.
Are Bollinger Bands effective in volatile markets?
Yes, Bollinger Bands can be effective in volatile markets, as they are designed to adapt to changes in price volatility.
During periods of high volatility, the bands expand further away from the middle band, providing wider trading ranges and potential breakout opportunities.
Can Bollinger Bands be used for long-term investing?
While Bollinger Bands are commonly used by short-term traders for timing entry and exit points, they can also be applied to long-term investing strategies.
Long-term investors may use Bollinger Bands to identify long-term trends, reversals, and buying opportunities in the market.
By combining Bollinger Bands with fundamental analysis and other investment strategies, investors can make more informed decisions and increase their long-term returns.
What is the significance of the middle band in Bollinger Bands?
The middle band in Bollinger Bands represents the average price of the asset over a specified period, typically a simple moving average.
It serves as a reference point for assessing the direction of the trend, and identifying potential support and resistance levels based on deviations from the middle band.
Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- John Bollinger – Bollinger Bands www.bollingerbands.com/
- Sam Eder – The Advanced Forex Course for Smart Traders 2.0 https://marketmates.com/course/
- TradingView Charting Program https://www.tradingview.com/
