How To Trade Using the Concept of Bollinger Bands

Introduction

Among various trading indicators, Bollinger band has a considerable edge as it provides multiple entry and exit tactics.

Bollinger bands was developed by John Bollinger in the early 1980’s. The basic idea behind creating Bollinger bands was to identify whether the price of an asset is relatively high or low.

Following image is an example of Bollinger bands:

An Example of Bollinger Bands

Bollinger bands is a set of 3 bands as depicted in the above image:
· Basis or the Central band

· Upper Bollinger band

· Lower Bollinger band

The Basis or The Central Band is made up of 20 period Simple Moving Average(SMA). SMA is the average closing price of an asset depending on any considered timeframe.

The Upper and Lower Bollinger Bands are plotted at a Standard deviation of 2 from the Central band.

The standard deviation of 2 from the Central band implies that 95% of the time, the price of an asset will stay within the range of upper and lower Bollinger bands.

The 20 period SMA and Standard deviation of 2 are default parameters, you can tweak them accordingly. But it has been observed that Bollinger bands function exceptionally well on the default parameters itself.

Trade Setup using Bollinger bands

Let’s discuss a few trading setups with the help of Bollinger bands. Following are few techniques which can be used as per your comfort.

Trading on the Retest of the Central Band

Here, we will discuss this technique with respect to buying and selling scenarios.

Buying Setup

Buying Setup

Things to observe before going long:

1. Check for the Dominance of Buyers. Whenever price crosses above the Upper Bollinger band, It is considered that buyers are significantly present.
2. Now, remembering that, 95% of time, the price ranges between the Bollinger bands, we must wait for the price to fall upto the basis.
3. Check whether the price is forming a support near the basis or not. A good bullish candle near the basis, signifies support. We can also consider the consolidation of price near the basis as a support zone.
4. For a perfect entry, wait for the price to Breakout above the identified support.
5. Now that you have observed this setup, Voila! You can go long!
   But wait, your stop loss can be placed below the support.

Tip: For better results, always practice the risk to reward ratio of 1:2.

Selling Setup

Selling setup

Things to observe before going short:

1. Check for the Dominance of Sellers. Whenever price crosses below the Lower Bollinger band, It is considered that sellers are significantly present.
2. Again, remembering that 95% of time, the price ranges between the Bollinger bands, let’s wait for the price to rise upto the basis.
3. Check whether the price is taking a resistance near the basis or not. A good bearish candle near basis signifies resistance. We can also consider the consolidation of price near the basis as resistance zone.
4. Wait for the price to breakdown below the resistance. In the above example, resistance was confirmed with the help of a single bearish candle. Thus let’s wait for the price to come below the low of the candle.
5. Once the above conditions are met, we can sell short the asset! Now, in this case, Stop loss can be placed at or above the high of the bearish candle.

Tip: For better results risk to reward ratio of 1:2 can be practiced.

Note: Selling short a stock through cash market, can be done only in intraday. In order to sell short a stock for more than 1 day, prefer derivative segments i.e. futures or options

Trading the Bollinger Band Squeeze

Generally, when price of an asset moves in a very narrow range, the basis, upper band, and lower band also run parallel to each other in a very narrow range. Such condition is known as the Bollinger band squeeze.

Bollinger Band Squeeze

Buying Setup

Following is an example of a Buying setup:

Buying Setup

1. Once Bollinger band squeeze is observed, wait for the price to breakout above the Upper Bollinger band. A good bullish Breakout candle must form as shown above. Do prefer breakouts with good volumes.
2. Done, go long above the high of the breakout candle! Stop loss can be placed below the low of the breakout candle.

Selling Setup

Want to know when to sell, see the image below:

Selling setup.

1. Once Bollinger band squeeze is observed, wait for the price to breakdown below the Lower Bollinger band. A good bearish Breakdown candle must form as shown above. Prefer breakdown with good volumes.
2. Now, just sell short the asset below the low of breakdown candle. Set the Stop loss above the high of the same candle.

So, these were the two techniques related to Bollinger bands concept. Hope these help you in minimizing the risks, and maximizing your profits!

Conclusion

There are many more setups related to Bollinger bands but for them, stay tuned to my upcoming blogs. Using these two setups you can trade profitably in the market. Provided that proper risk management is followed i.e. risk to reward ratio of 1:2 is practiced. I know I am being quite repetitive on this point, but that is really very important and a practice to abide by in all your trades.

Also, discipline is the key to become a profitable trader. Proper entry and exit rules must be followed. Placing random trades, not following a proper trading setup, jumping from one strategy to other, and not exiting the trade in case of stop loss being hit are only a few major reasons that lead to failure of a trader. Make sure that such mistakes are avoided.

Remember the key mantra:

Devote Dedicated Discipline for Success!

Good luck traders! Hope you enjoyed my first blog. Stay tuned for more!