How Bollinger Bands work and what is their purpose in your trading

Do you you know who is the creator of Bollinger Bands and why was he using them? Watch our Bollinger Bands tutorial, to get a profitable Forex trading.

Bollinger Bands – A beginner’s guide

Hello and welcome to Diary of a Trader. Today’s video is going to be on Bollinger Bands and we’re going to explain how they work, what is their purpose and how to implement them into your trading. They are a fairly common indicator and we’ve known about Bollinger Bands for quite some time, they were created by a gentleman named John Bollinger, and he has a whole website dedicated to this indicator. And, if you’re not familiar with where to find it on TradingView, you just go to Indicators and if you just type in BB and we have Bollinger Bands right here, okay? There are also two comforting indicators that you can use, Bollinger Band Width and The Percent, but for right now, we’ll just look at the indicator itself.

Now, there are three components to the Bollinger Bands. There is an upper band, a lower band and then the middle. The middle is just a simple moving average and TradingView has a default by 20, but I believe John Bollinger had it set to 21. And, without going into a lot of the specifics about the calculations that go into measuring these, we just need to understand that Bollinger Bands are a measure of volatility. So, it’s measuring the action and the direction and how powerful the drive up or down is, and then that is reflected inside our Bollinger bands. And so, I’m looking at the Euro/Dollar, right now, and if we look at this zone here, we can see that as price was moving down pretty heavy, the Bollinger Bands, they expanded, they got very, very… They moved up, they got wider, so they formed like a big bubble, okay? And then, it traded outside and came back in. And then, what happened? The Bollinger Bands, they constricted. This is called a Squeeze or a Bollinger Band Squeeze, or sometimes people just call it a Squeeze. Now, the squeeze, depending on who you talk to, this is the source of some contention here, whether does a squeeze happen before a move or does it happen after a move? This is one of those chicken and the egg arguments, but that’s not really important. All we need to know is that, after a big move, we do see Bollinger Bands enter a squeeze, which means we’re reduced volatility, it’s just a consolidation, and then we also know that squeezes precede breakouts. And so, when we know we are in a squeeze, this is the time for us to be aware. This is the time for us to watch, to see, what is happening with price. So, we see some consolidation and then price moves beyond and up. When it starts to trade above the cloud, this is called kind of riding the cloud. This is generally a very, very bullish, well, even if it’s bearish, like down here, if price is riding the upper band, that is a sign of a very powerful trend and you don’t want to trade counter to this. Bollinger Bands will keep you in trades if you trade this smartly.

Now, notice and observe what happens where we started to enter a squeeze over a short period here, but then we traded up and it fell back down, so how do you know that this is going to fall? Well, this is where you start to use some other indicators. Let’s take a look at the Stochastic RSI, and maybe just the RSI itself. And we’ll get rid of these other two indicators for right now. Now, if you’re not familiar with these two indicators, without going into a whole lot of detail, we know that if price is trading above the 70 level on the RSI, that that is considered to be an overbought market. So, there’s a reduced chance of prices moving higher and an increased chance of them moving lower. Similarly, with the Stochastics, if we see a big spike like this, if we see price is up trading in this range, then we know that prices may fall down and if they’re down here if price is down here, then we know that prices may trade up. And if we use them in combination with one another, we have a very, very easy to identify a trading system that we can follow, with the Bollinger Bands.

So, let’s look at something, a different price, or a different instrument. Let’s look at the Pound/Dollar. Now, if we were not using any indicators we would see that we have a squeeze here that forms, the Bollinger Bands are tight and then they expand because price is trading and it comes back down and we’re moving here. And then, we see price fall down here, only to trade back up. And this is where somebody might think, “Well I can go along now” because price was rejected lower. Well, this is where our indicators come into play. This is where we use other forms of market analysis, to help us. If we saw price trading above the Bollinger Bands, we know automatically that means that price is moving in an extreme. But then, if I look at my stochastics, the Stochastic RSI, I know that I’m at an elevated level. I know that it’s hard for price to continue higher here. The RSI is still neutral, it’s not overbought, but it is near an overbought level. So, the highest probability of price and the direction is to go down, and then we observe that we see it coming down, falls below the moving average and then this is a good signal too. When you are in a squeeze and then you break out, whichever direction you break out, wherever you retest the middle line here, that is usually a good pullback trade. So you can re-enter a short here. And so, we would enter that short, and that’s confirmed buy, well, we’re not oversold and we are elevated in the stochastics indicator. And so, we would take a short. And when we saw price getting back inside the Bollinger Bands, that’s our signal to consider selling and taking some profit. Additionally, price is right here, and where is the RSI? In deep oversold territory and the Stochastics RSI is in deep oversold territory. So, this is where we could consider covering that short and possibly going long, but we don’t want to go long yet until we hold above the 20, okay?

So you can see that the proper application of the Bollinger Bands with other indicators can help yield very, very high quality and high probability trades. Lots of winning opportunities, when you use the Bollinger bands with your indicators. Now, it’s very important to notice that when you’re looking at an instrument that is in a squeeze, it can be in a squeeze moving up and it can be in a squeeze moving down. But a flat area, trying to find one here for you, but a flat area of a squeeze, like right here, these indicators will help us find false breakouts. So we’re trading here and then we trade down, okay? We start to trade below the lower band here, the lower Bollinger Band. And this is telling us that this is a fake breakout. Why Because we are in these extended conditions in our oscillator. And this is where we observe price is going to change and move in a different direction. Thank you for watching this video. Hope you found it helpful, and we look forward to seeing you at our next video.