Bollinger bands are technical indicators that are common in trading currencies, futures, and stocks. Often, Bollinger bands are used to determine oversold and overbought levels or checking for breakouts. Mainly, Bollinger bands comprise of three lines.
A standard calculation of Bollinger bands typically utilizes a 20-day moving average in the middle band. To calculate the upper hand, you add twice the normal standard deviation to the middle band. On the other hand, to compute the lower band, you take the middle band and then minus twice the normal standard deviation.
1. Oversold and Overbought Strategy
As mentioned earlier on, Bollinger bands are commonly used by traders to identify oversold or overbought market conditions. When prices of a commodity fall on the lower band on the Bollinger Bands, traders can opt to enter a long position and wait for the price to move back to the middle band. More so, the strategy will depend on the mean reversion that affects the prices. Bollinger bands help to identify whether asset prices misalign with the mean.
This strategy also works well in range-bound scenarios where prices travel intermittently like a swinging pendulum. Nevertheless, Bollinger Bands are not always accurate in providing buy and sell signals. To make effective use of Bollinger Bands, you can study the change of price direction and then use only trade signals that align with this trend. For instance, when the trend falls, you should only use short positions.
Bollinger Bands: 2-Fold Strategy to Study Trends Click To Tweet2. Squeeze Strategy
Another technique you can use with Bollinger Bands is known as squeeze strategy. Often, a squeeze can occur when the price starts moving sideways. Traders can identify when prices are consolidating since both the lower and upper bands come close to each other. When this happens, you will know that the commodity you are trading in has become volatile. After consolidation occurs, the price can move in either direction, but on high volume.
Key Talking Point
While Bollinger Bands are a practical way of identifying oversold and overbought trade signals, traders can also use multiple bands to highlight price changes. Alternatively, traders can utilize Bollinger bands to identify volatility contractions.
Subscribe onto tradingview.com for free to get great ideas from other traders.