Bollinger Bands

Bollinger Bands are a technical analysis tool, or to be more precise, they are an indicator consisting of three lines that form a channel and show price deviation. The world first learned about Bollinger Bands thanks to the publication of the famous book “Bollinger on Bollinger Bands” by author John Bollinger.

In the book, the author describes in detail how to use his tool, provides statistical information and gives interesting instructions to investors that will allow them to avoid typical mistakes.

Initially, the indicator was intended for trading stocks and futures on the stock exchange, but due to its high popularity and effectiveness, stripes also began to be used in the Forex market. 

The well-known trading rule, sell at a higher price and buy at a lower price, turned out to be difficult to apply in practice when trading, since it is always difficult to choose the maximum and minimum points. John Bollinger tried to solve this problem, so the top line should be taken as the market minimum, and the top line as the maximum.  

The indicator is considered trendy because it is based on a simple moving average with a period of 20. Many people mistakenly believe that the upper and lower lines have complex calculation formulas, but in fact the upper line is calculated by adding two standard deviations from the moving average, which is the central line .

 The lower line is calculated in a similar way, but in this version two standard deviations are subtracted from the average line. The philosophy of creating the indicator is extremely clear, the author claims that the price always tends to be near the average value, therefore, after sharp surges on different sides, it always tries to balance out at the middle line of the trading channel.  

According to Bollinger, the price is inside the channel 90 percent of the time, and going beyond its boundaries indicates a strong deviation, which marks a trend.

A characteristic feature of the indicator is that the distance between the lines directly depends on market volatility . So, for example, when volatility increases, the channel expands, and when it decreases, it narrows. Therefore, thanks to the indicator, you will be able to determine whether the trend is currently raging or the market is in the accumulation of strength. Bolinger argued that after each narrowing of the channel one should expect a strong surge in price, and after each strong expansion of the channel a flat will soon occur.

Most beginners when building a system based on this tool mistakenly add volatility and trend indicators, however, due to the fact that both of these functions are already taken into account in the formula itself, duplication of indicator purposes appears, which leads to the complication of the trading system, but not to an improvement in its efficiency. Therefore, Bollinger Bands must be combined with an oscillator.

This tool is built into well-known trading platforms by default, and in the MT4 trading terminal you can find it in the trend indicators section, where it is called “Bollinger Bands”. By default, the indicator uses a moving average with a period of 20 and a deviation of 2, but the author of the tool offers an alternative offers for short-term trading on a small time frame a moving period of 10 and a deviation of 1.9, and for long-term trading on higher time frames a moving period of 50 and a deviation of 2.1.

The indicator is very popular among different groups of traders because it is multifunctional. And in the next article we will look at the use of the indicator in trading and use examples to show the trading signals it gives.