The relative strength index (RSI) is an indicator used in technical analysis to measure the momentum of recent price changes.
Trading strategies with Bollinger Bands
2021-09-16 • Updated
In the previous article, we explained how to trade using Moving Average. Now it’s time to look into another useful indicator called Bollinger Bands. The indicator is available not only in MetaTrader but also in FBS Trader App.
What are Bollinger Bands?
It’s a technical indicator that got its name after its maker – famous trader John Bollinger. Bollinger combined three Moving Averages in a single indicator. The middle line is a Simple Moving Average and so are the outer bands with the exception that they are shifted upper and lower to create a sort of channel.
How to use Bollinger Bands in trading?
The biggest advantage of this indicator is that it offers traders a great tool of visual analysis. It’s assumed that the price spends about 95% of the time inside the Bollinger Bands channel. As this channel is made of Moving Averages, it widens and narrows together with the swings of the price reflecting volatility. As the price spends just 5% outside the Bands, traders track the situations when it leaves the Bollinger channel. Most often, the price spends no more than four candlesticks above the upper Bollinger Band or below the lower Bollinger Band and then a correction takes place. Knowing this allows trading on the price’s reversal and return to the middle line. This approach works best when the market is in a range or a slow trend.
The middle line can also act as dynamic support/resistance. In a strong uptrend, the price moves mostly between the upper band and the middle band.
Which settings to choose for Bollinger Bands?
By default, the settings are ‘20’ for the period and ‘2’ for the deviation. This is a classic set of parameters used by most traders. However, you may try other periods and deviations. The general recommendation is that the number for periods should be between 13 and 24, while the deviation should be in the range between 2 and 5.
Period. The smaller the period, the more times the price will touch and leave the outer Bands. On the one hand, this means that there will be more signals. On the other hand, more signals will be false. At the same time, when the period is too big, the indicator becomes less sensitive. As a result, as with many other things in life, it’s necessary to find a balance.
Deviation. Higher deviation moves the outer bands further apart. If the Bands are so wide that the price never touches them, the indicator loses much of its usefulness. So start with ‘2’ and see if it’s necessary to make any changes or not.
Trading strategies with Bollinger Bands indicator
Strategy #1 – Mean reversion strategy
This strategy relies on the fact that after deviating too much from the average level, the price tends to return to it.
- Find a sideways (horizontal) range on the chart.
- Look for reversal candlestick patterns when the price reaches the upper Bollinger band:
For a BUY order
If a pin bar candlestick with a long lower shadow appears at the lower Bollinger band, open a Buy order above this candlestick. Put Take Profit at the middle/upper Bollinger Band and a Stop Loss below the pin bar’s minimum.
For a SELL order
If a pin bar candlestick with a long upper shadow appears at the upper Bollinger Band, open a Sell order below this candlestick. Put Take Profit at the middle/lower Bollinger Band and a Stop Loss above the pin bar’s maximum
You can use a 100-period Moving Average as a filter: consider only BUY trades when the price is above this line and only SELL trades when the price is below this line.
Strategy #2 – Squeeze strategy
The strategy is built on the idea that after the market calms down, there will be a spike in volatility and a breakout.
- Find a situation on the chart when the price moves in a very narrow range (Bollinger bands move close together).
- Buy on the breakout above the upper Bollinger Band and sell on the breakout below the lower Bollinger Band.
- Put the Stop Loss outside the consolidation range on the opposite side of the breakout.
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