How to Trade with the Bollinger Bands Indicator

 

Hello there, this is tradingpedia.com and this video deals with the Bollinger Bands indicator – a technical analysis video. The Bollinger Bands video is one of the most famous indicators in the world, developed by John Bollinger, who is still well and alive and there is literally no trader in the world not knowing how to trade with it.

Where to Find It

This is a trend indicator, to be found on the MetaTrader4 platform under Insert/Indicators/Trend and then Bollinger Bands here. Any trend indicator appears on the main chart window, in comparison with an oscillator that appears in a small window at the bottom of the chart.

The Bollinger Bands indicator can be edited in order to modify the periods considered. This one considers 20 periods before applying the indicator and if we click ok, it looks like this. It has three lines – the lower Bollinger Band (LBB), the middle Bollinger Band (MBB) and the upper Bollinger Band (UBB).

Over 90% of the time the price remains between these lines. Therefore the idea is to catch a rising or a falling trend, in order to participate the most to the price action and profit from it.

Strategies

Various strategies exist to profit from this indicator. Usually the MBB is a moving average that sits close to the price, an exponential moving average, but also a simple one can be used.

What bulls like to see in a rising trend like to see the price action sitting in the upper part of the Bollinger Bands indicator and in a bearish trend, bears would like to see the price action in the lower part. So how to trade a bearish setup with this indicator? Simply going short on a break lower, have a stop loss at the UBB and trailing the stop. Trailing it means that the more the price falls, the UBB follows the price and you will be able to trail the stop.

Another way is to look at reversal patterns forming on the MBB. For example, this is a bearish cross, when the price moves below the MBB line. What trades do; they look at candlestick reversal patterns at the MBB line.

In this case, this small candlestick is a shooting star, a reversal pattern against the MBB, a nice place to go on the short side and set a stop loss at the UBB. Then look at 1:2 risk-reward ratio or bigger, depending on the aggressiveness of the trade.

Another thing to do is to interpret the breakouts above or below the extremes. If the bands are able to contain the price for more than 90% of the time, it is normal to interpret these breakouts as a sign of the trend to come. The market first broke below, a sign that the market is bearish, so trade reversal patterns on the MBB. Or, when the price broke here above the UBB, is a sign of a strong trend, so trade reversal patterns on the MBB. For instance, these two are called morning stars, and so on.

Last but not least, the Bollinger Bands indicator offers the possibility to use it as a volatility indicator in the sense that the ranges increase or decrease with the market activity. When the market moves quickly, the volatility increases, and the bands expand. When the market is slow, like here, you will see a very small distance between the UBB and LBB.

The key is to find out when a breakout will come. You can measure this distance, by using historical prices to find the narrowest possible distance between the bands, you measure it and use it as a filter moving forward.

Every time the indicator shrinks less than the measured length, it means that a breakout follows and when the volatility increases you wait for the price to go to the extremes and trade in that direction. For instance we see here that the volatility decreases below the threshold and then the market broke higher above the UBB. This is bullish, and for the next eighteen trading days the AUDUSD traded with a bullish tone. You may use that in your favor either using swing or scalping on lower timeframes until the conditions change.

Conclusion

To sum up, there are three ways to use the Bollinger Bands indicator. One is to stay on the upper half until the bullish trend reverses or to remain on the bearish half until the trend reversal. Another one is to add to a position by looking for reversal patterns on the MBB. Finally, use it as a volatility indicator as a great tool of finding breakouts as the price spends over 90% of the time between the UBB and LBB.

These are only some of the ways to use the indicator – others exist. But with these you should be on the right side of the market in the sense that following with a trade that has a stop-loss and a risk-reward ratio bigger than 1:2 is good money management coupled with an indicator’s use.

Thank you for being here, bye bye.