Tips For Bollinger Band Trading

Bollinger bands are an extremely useful trading indicator, often used by traders of all strategies and preferred time-frames. 

An example of the Bollinger bands on a chart.

According to Wikipedia, the Bollinger Bands “are a technical analysis tool developed by John Bollinger. There are three lines that compose Bollinger Bands: A simple moving average (middle band) and an upper and lower band. The upper and lower bands are typically 2 standard deviations +/- from a 20-day simple moving average, but can be modified.”

Now that you have an exact definition of what they are, here’s some tips on how you can* use them effectively and safely.

• The Bollinger Bands provide a relative definition of high and low.
• The relative definition can be used to compare price action and indicator action, to arrive at rigorous buy and sell decisions.
• Appropriate indicators can derive from momentum, volume, sentiment, open interest, intermarket data, etc.
• Volatility and trend have already been deployed in the construction of the Bollinger Bands, so their use for confirmation of price action is not recommended.
• The indicators used should not be directly related to one another. For example, you might use the ‘one-momentum’ or ‘one-volume’ indicator successfully, but the two-momentum indicators aren’t better than one.
• The Bollinger Bands can also be used to clarify pure price patterns such as M-tops and W-bottoms, momentum shifts, etc.
• The price can, and does, walk up the upper Bollinger Band and down the lower Bollinger Band.
• Closes outside the Bollinger Bands are continuations, not reversal signals (this has been the basis for many successful volatility breakout systems.)
• As the default parameters for the moving average line is ’20 periods’, this forms the basis for the standard deviation calculations, of which two standard deviations form the bandwidth as the defaults. Such parameters may require tailoring for any given market.
• The ‘average deployed’ should not be the best one for crossovers. Rather, it should be descriptive of the intermediate-term trend.
• If the average is lengthened, the number of standard deviations needs to be increased simultaneously; from 2 at 20 periods to 2.5 at 50 periods. Likewise, if the average is shortened, the number of standard deviations should be reduced; from 2 at 20 periods to 1.5 at 10 periods.
• The Bollinger Bands are based on a simple moving average. This is because a simple moving average is used in the standard deviation calculation, and it is good to be logically consistent.
• Make no statistical assumptions based on the use of the standard deviation calculation in the construction of the bands. The sample size in most deployments of the Bollinger Bands is simply too small for statistical significance.
• Indicators can be normalised with ‘%’, by eliminating fixed thresholds in the process.
• Tags of the bands are just tags, not signals. A tag of the upper Bollinger Band shouldn’t be treated as a ‘in-of-itself’ sell signal. The same applies to a tag of the lower Bollinger Band. It is not considered an ‘in-of-itself’ buy signal.

*Five minutes spare and it’s employees are not financial advisers or professional traders. Most traders lose money and it isn’t a suitable method of investment for everyone. Trade responsibly and at your own risk. This article is for educational purposes only based on past events in the market. Past events aren’t an indicator of future market events. Do your own research and back testing. Again, we are not financial advisers.