Bollinger bands are known as oscillator indicators which help to measure price volatility.
They assist us to monitor whether a price is high or low compared to its recent average and predict when it might rise or fall back to that level. This will help you decide when to buy or sell an asset.
Bollinger bands show overbought and oversold markets.
It is comprised of three main bands or lines.
The RSI helps to time the entries and exits to maximize profits before there is a rise or fall in price.
A.Central band
B.Upper band
C.Lower band
The central band depicts the price's simple moving average.The upper and lower bands represent levels where the price is considered relatively high or low compared to its recent moving average.
The illustration chart below depicts how Bollinger bands look like on a price chart.
Most of the price action is generally contained within the bands and this can help predict market reversals.
Overbought
It is overbought when the price reaches the upper band; the asset trades at a higher price.Look to sell the asset as the price tends to fall back towards the central moving average band.
Oversold
It is oversold when the price reaches the lower band; the asset trades at a lower price.Look to buy the asset as the price tends to go back towards the central moving average band.
The bands assist us in measuring how volatile a market is based on the distance between the upper and lower bands.
Big space between the bands - high volatility
Narrow space - low volatility
Practice session:
Exercise 1:Find the sell signal. Show exercise
Exercise 2: Find the area with higher volatility. Show exercise
Changing the Bollinger band settings
There are two different settings that you can change on the Bollinger bands indicator: the number of periods and the standard deviation.
Changing the periods
The standard setting for the Bollinger bands is 20 periods (or 20 candles). This refers to the length of time over which the indicator is calculated from the price action.
Using fewer periods
Lower than 20, more trading signals can be expected including false ones.
Higher than 20, minimal false trading signals can be expected but trading opportunities may be missed.
Using a smaller number of periods makes it more reactive and results in uneven upper and lower bands.
Bollinger Band Indicator Setting
Periods 20
Standard Deviation 2
Moving Average Type :
Simple Moving Average
In the illustration chart below, the indicator has a setting of 10. We can notice the price breaking the upper and lower bands more often:
Bollinger Band Indicator Setting
Periods 10
Standard Deviation 2
Moving Average Type :
Simple Moving Average
Using more periods
Setting a higher number of periods will make it less reactive and result in smoother lines.
The price breaks the upper and lower bands less often, giving less, but more reliable signals.
Changing the standard deviation
The standard deviation setting of the Bollinger bands is 2.
The standard deviation refers to how much of the data from the moving average's normal distribution pattern are included in the bands.
Increasing the standard deviation increases the distance of the bands from the central line and so more of the price action is contained within them.
So, a setting of 1 standard deviation means that 68% of all price action is contained within the bands, whereas increasing the standard deviation to 2 – and hence increasing the distance from the central line – means that 95% of all price action happens within the bands.
The settings appear in the top left-hand corner of the chart, and would normally show as '20, 2' under the default settings.
Decreasing and increasing the standard deviation
The standard deviation has been adjusted to 1.9 in the chart below.
Bollinger Band Indicator Setting
Periods 20
Standard Deviation 1.9
Moving Average Type: Exponential moving average
The upper and lower bands are now close together.
The price breaks the bands more often, as opposed to when you increase the standard deviation to, say, 2.1 in the following chart:
Bollinger Band Indicator Setting
Periods 20
Standard Deviation 2.1
Moving Average Type : Simple Moving Average
We can notice that the following chart is an illustration where the Bollinger bands standard deviation settings have been set to 2.5 and the price breaks the bands less often:
Bollinger Band Indicator Setting
Periods 20
Standard Deviation 2.5
Moving Average Type : Simple Moving Average
We are successfully altering the levels of extremes that the price has to go in order to break through them.
This is possible by increasing the standard deviation of the Bollinger bands.
The price will break through the Bollinger bands with a higher standard deviation less often, these higher settings potentially give us more reliable signals.
Nut Shell:
An overview of the lesson discussed so far….
Bollinger bands are known as oscillator indicators which help to measure price volatility.
They assist us to monitor whether a price is high or low compared to its recent average and predict when it might rise or fall back to that level.
It is overbought when the price reaches the upper band; the asset trades at a higher price.
Look to sell the asset as the price tends to fall back towards the central moving average band.
It is oversold when the price reaches the lower band; the asset trades at a lower price.
Look to buy the asset as the price tends to go back towards the central moving average band.
A big space between the upper and lower bands indicates price volatility is high, a small space indicates it is low.
Increasing the periods used will make the Bollinger bands smoother and the price will break the bands less often.
Decreasing the periods will make the bands uneven and the price will break them more often.
Increasing the standard deviation will increase the distance of the bands from the central lines and the price will break the bands less often.
Decreasing the standard deviation will decrease the distance of the bands to the central band and the price will break them more often.