Developed by John Bollinger in the early 1980s, Bollinger Bands (BBs) are a technical trading tool traders use to measure pricing volatility. Vast numbers of equity, forex, and futures traders routinely employ their functionality in countless strategies. If identifying market state and dynamic pricing volatility is important to you, then Bollinger Bands and trading strategy applications are certainly worth a look.
What Are Bollinger Bands?
According to John Bollinger, BBs are a type of “trading band” or “envelope.” In practical terms, Bollinger Bands are two trendlines that depict the standard deviation of price from a predetermined moving average. The beauty of BBs is that their inputs are customizable. The moving average may be simple, exponential, or smoothed; standard deviation values are variable, typically landing in the 2.0 range.
Here’s a brief look at the essential components of Bollinger Bands:
- Upper band: The upper BB represents a positive variation from a moving average. This value is derived by adding a standard deviation value to the simple moving average (SMA).
- Lower band: The lower BB is an illustration of negative variation from the moving average. To determine the lower BB, a standard deviation value is subtracted from the SMA.
- Midpoint: The midpoint is the central value between the upper and lower bands.
Although the math is relatively straightforward, manually calculating BBs in live market conditions is a nonstarter. Fortunately, most software trading suites perform the derivations automatically. The only tasks required are to select a moving average type and a standard deviation value, and robust platforms such as dt Pro do the rest.
Interpreting Bollinger Bands
Perhaps the single largest advantage of BBs is that traders can use them to quickly identify trending, range-bound, overbought, and oversold markets. Here are a few frequently implemented Bollinger Bands and trading strategy parameters:
- Bullish trend: Within the context of Bollinger Bands, a bullish trend may be present when a periodic pricing bar closes above the upper band. When this event occurs, traders may hold or enter a long position in anticipation of the uptrend extending. Given this scenario, the distance between the upper and lower BBs is wide, indicating enhanced volatility.
- Bearish trend: BBs signal that a bearish trend is present when a periodic pricing bar closes beneath the lower band. This event suggests that the downtrend will continue and that holding or entering a short position is appropriate. Like the bullish trend, the space between the upper and lower bands is wide.
- Reversals: In many instances, a market may be viewed as overbought or oversold when price reaches the upper or lower BB. Accordingly, traders may play a reversal strategy, selling the upper band and buying the lower band. Like the bullish/bearish trend strategies, reversal conditions are optimal when the space between the BBs is significant.
- Rotational markets: In contrast to trend and reversal strategies, rotational markets may also be traded using BBs. A “slow” market is evident when the distance between the upper and lower BBs is small. To capitalize on the muted action, a trader may sell the upper band and buy the lower band. Stop losses are typically modest, with the profit target being located at or near the midpoint.
No matter what you’re trading, whether it’s WTI crude oil or the Euro FX, you can easily integrate Bollinger Bands into your strategy. You can automatically apply them to any security on any time frame via your software trading platform. When it comes to quickly discerning volatility and market state, BBs are among the most referenced technical indicators in the public domain.
Want to Learn More About Bollinger Bands and Trading Strategy?
In the online space, there are literally thousands of methodologies readily available to futures market participants. Of course, not all are created equal. For legions of active traders, combining Bollinger Bands and trading strategy is a no-brainer.
To learn more about the functionality of BBs and other technical indicators, check out Daniels Trading’s trading guide Technical Analysis for Beginners. In it, you’ll find information that can help you get up and running as a futures market technician in no time.