Understanding Bollinger Bands
Bollinger Bands is a trend indicator that measures price volatility and dynamics in financial markets. Developed by John Bollinger in the 1980s for stock trading, it has become a standard tool in platforms like MetaTrader 4. This indicator helps traders assess market volatility and predict whether a current trend will reverse or continue.
How Bollinger Bands Appear on Charts
The Bollinger Bands indicator consists of three directional lines:
- Middle Band: A 20-day Simple Moving Average (SMA).
- Lower Band: The middle band minus two standard deviations.
- Upper Band: The middle band plus two standard deviations.
👉 Discover how Bollinger Bands can enhance your trading strategy
The Bollinger Bands Formula
Calculating the Middle Band (CL)
The middle band is calculated using the SMA formula with the closing prices of the last 20 bars:
[
CL = \frac{\sum_{i=1}^{N} Close_i}{N}
]
Where:
- ( CL ) = Middle Band
- ( Close_i ) = Closing price of the ( i )-th candle
- ( N ) = Time period (typically 20)
Calculating Standard Deviation (SD)
Before computing the upper and lower bands, the standard deviation must be determined:
[
SD = \sqrt{\frac{\sum_{i=1}^{N} (Close_i - CL)^2}{N}}
]
Upper and Lower Bands
- Lower Band (LL):
[ LL = CL - 2 \times SD ] - Upper Band (UL):
[ UL = CL + 2 \times SD ]
Practical Calculation Example
Let’s use EUR/USD closing prices from early 2016 to demonstrate the calculation:
| Day | Closing Price | Middle Band (CL) | Standard Deviation (SD) |
|---|---|---|---|
| 21 | 1.0887 | 1.0866 | 0.0050 |
| 22 | 1.0918 | 1.0869 | 0.0050 |
| 23 | 1.1102 | 1.0877 | 0.0042 |
Upper Band for Day 21:
( UL = 1.0866 + 2 \times 0.0050 = 1.0967 )
Lower Band for Day 21:
( LL = 1.0866 - 2 \times 0.0050 = 1.0765 )
Trading Applications of Bollinger Bands
Key Strategies:
- Price Range: Prices typically fluctuate between the upper and lower bands. A touch of one band often signals a move toward the opposite band.
- Trend Identification: Prolonged price movement near the upper/lower band indicates a strong uptrend/downtrend.
- Squeeze and Breakout: Narrowing bands suggest low volatility, often followed by a sharp trend after a breakout.
- Reversal Signals: Two consecutive highs/lows (one outside and one inside the bands) may signal a reversal.
👉 Learn advanced Bollinger Bands trading techniques
Pro Tips:
- Combine Bollinger Bands with other indicators (e.g., RSI, MACD) for confirmation.
- Adjust settings (e.g., SMA period, standard deviation multiplier) based on asset volatility.
Frequently Asked Questions (FAQs)
1. What is the default setting for Bollinger Bands?
The standard configuration uses a 20-day SMA and 2 standard deviations.
2. Can Bollinger Bands predict exact price movements?
No. They indicate volatility and potential reversals but require confirmation from other tools.
3. How do I interpret a "squeeze"?
A squeeze (narrow bands) suggests low volatility, often preceding a high-volatility breakout.
4. Are Bollinger Bands suitable for all markets?
Yes, but settings may need adjustment for different assets (e.g., forex vs. stocks).
5. What’s the best time frame for Bollinger Bands?
They work across time frames, but shorter periods (e.g., 1-hour charts) suit day traders.
Sources
- John Bollinger, Bollinger on Bollinger Bands (ISBN 9780071386739)
- Bollinger Bands on MetaTrader
This guide equips you to leverage Bollinger Bands for smarter trading decisions. For further insights, explore our resources 👉 here.