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Wednesday, April 21 2021
Bollinger Bands? What are they and how do they help me?

 

Developed by veteran trader John Bollinger in the 1980's, the Bollinger Bands are an indicator  using a moving average with trend bands of equal distance above and below the moving  average. The middle of the Bollinger band is a 20 period SMA (Simple Moving Average) 

The bands on each side of the middle used most often are at the 1, 2 and 4 standard  deviations from the middle. These are called 1 sigma, 2 sigma and 4 sigma (shorthand for  standard deviation in statistics). For clarity we call the upper bands the +1, +2 and +4 sigma  and the lower bands the and -1, -2 and -4 sigma. 

See https://www.investopedia.com/articles/ technical/102201.asp for a more technical description. 

Most price action will occur between the +2 and -2 bands. 

What do Bollinger Bands indicate?  

The middle shows just what any moving average does, direction of trend and whether the  current PA (price action) is above or below the average.  

The bands visualize the change of volatility in the PA. When the bands are contracting, the  volatility is decreasing and when they are diverging the volatility is increasing, when they are  parallel the volatility has stabilized. 

How to use them:

Market Direction - the middle of the Bollinger band will point in the direction of the current  trend, commonly for the last 20 candles. If the bands point in the same direction the trend is  strong. 

Market Momentum - When the bands are diverging, price momentum is increasing in the  direction of the current trend. When the bands start converging, the trend is pausing, look for a  retrace. 

Warning - When the bands continue to converge and roll to change direction look for a  potential turn around. Another sign of a potential turn around is when the price is at the  extreme of the +4 or -4 sigma.

My favorite Bollinger signals 

3 Trips beyond the 2 sigma  

At least one candle, or several in a row, closes beyond the 2 sigma (either side) in a strong trend. After a  small pullback this happens again 2 more times, for a total of 3 trips beyond the 2 sigma, with  pullbacks or pauses in between. After the 3rd trip beyond the 2 sigma there is a strong chance of a trend  change or deep retrace. After the first trip beyond the 2 sigma, trade the pullback in the  direction of the trend for trip 2 and 3. Stop should be outside the trend support. After trip 3 watch for indecision, a channel break or additional confirmation like RSI divergence  for even stronger confirmation and trade against the trend as this will likely be a deep retrace or  even a trend change. Stop should be outside the high for a short trade  or low point for a long trade on the turn around.  

2 sigma to 2 sigma cross  

In flat or neutral price action like a box the price will often cross from one 2 sigma of the  Bollinger Band to the other in a +2 to -2 movement down or -2 to +2 movement up. Watch for  the typical turn around confirmation to enter the trade. Stop should be below the 2 sigma the  price is moving away from. This works best in a large box.

Potential Trend Change  

Price touching the +4 or -4 sigma band is a strong indication of a trend change 

Dynamic Channel  

When price is using bands, like the +1 sigma and +2 sigma as support and resistance acting like a dynamic  channel 

Targets  

When the price crosses the middle of the Bollinger strongly and the bands flare the +2 sigma becomes a  prime target for a fill in an uptrend.  The -2 sigma is a prime target fill in a downtrend. 

Summary  

Confidence in a trade is a key component for consistent trading. I used to always worry in a  strong trendy movement that the market would unexpectedly turn on me. While the  unexpected is always possible, when I see a pattern that recurs in the market like the three  trips beyond the 2 sigma, stack that with a strong trend, a well drawn channel, a standard turn  around or other patterns, I trade with more confidence and less worry. I can also have clear  boundaries to manage my risk with greater accuracy because the moment the pattern fails it  is obvious and I can manage the trade. So, whether the pattern holds or fails, it tells me  something important about the current PA that I can use to inform my next trade.  

Bollinger bands are a great indicator when combined with more basic indicators to add  confluence and increase confidence in your trade decisions.

 

Randy S, TX

 

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