BOLLINGER BANDS are some of the most popular bands in trading, but most people don’t know how to use their full potential…
The best book on this subject is straight from the horse’s mouth – John Bollinger’s book: Bollinger on Bollinger Bands
In the mean time, here are six easy ways in which to interpret Bollinger Bands:
1. Squeeze breakouts. This is the most popular way to trade Bollinger Bands. The theory is that the market cycles between periods of high and low volatility. When Bollinger Bands squeeze together, it shows a period of low volatility. Traders then position themselves for a breakout trade as volatility runs back into the market. (If you are a good trader, then you will have an opinion as to which direction it will go. It is rare that the bands need to be bracketed.)
2. The increasing volatility signal. This signal occurs when the top band and the bottom band are moving in opposite directions. This shows that volatility is increasing in the market, and if there is evidence of a trend, it is usually a signal to stay in a trade as the trend is beginning. (Of course, if price breaks back into the original squeeze range, it is just a sign of a volatile market.)
3. The steady trend signal. Here, the bands are pointing in the same direction. It shows a steady up or downtrend, depending on the direction of the bands. This kind of market is usually in an upward channel, and people can trade it by entering on pullbacks (usually to the 20 EMA, which is a favourite area amongst the retail crowd).
4. The end-of-trend signal. The end of trend signal occurs at, well, the end of the trend. In an uptrend, this occurs when the top band curls down slightly. That is usually a signal that price is going to either consolidate sideways, or more often go down to touch the other band in a range-type motion. This is especially significant if price can close past the 12 EMA.
5. Support and resistance. There is usually a level of support and resistance at the top and bottom bands.
“Sure…tell me something I don’t know.”
Okay. Most people look at this support and resistance on the current timeframe. Clueless traders usually miss these levels COMPLETELY when they occur on the higher timeframe. If you are trading the 15M, look for these levels on the 1H chart. On the 1H, monitor the 4H. The 4H corresponds to the daily.
Each timeframe is related to the next by a factor of 3-6. (5M x 3 = 15M, 15M x 5 = 1H, 1H x 4 = 4H, 4H x 6 = Daily, Daily x 5 = Weekly) You get the idea. If people were more aware of these levels, they would run into far less trouble.
6. Reversion to the mean. If you are trading reversal divergence, or if you have a reason to believe price will turn at a certain level, watching the INNER Bollinger Bands will give you an early signal of this happening. Most do not use the inner bands – you have to put a second set of bands on your chart, and change the standard deviation setting to 1, or 1.618. Once price has been outside the bands, closing inside the inner bands is a signal that it is about to turn. By itself, this is merely an interesting fact. Combined with analysis of trend, cycle, momentum, time and timeframes, it can be a potent entry trigger.
With best wishes for your trading,
Private Fund Trader/Head Trader Consultant
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