Whether you want to make a short-term or long-term trade, it’s essential to arm yourself with the right trading strategy for increasing trade profitability. Having a detailed trading strategy decreases the risk of losing money and increases confidence.
But which trading strategy should you choose? Well, you can consider using the Bollinger Bands trading strategy because it’s easy to use. The simplicity of this strategy makes it manageable for traders to get a better understanding of the market.
Below are some of the details of this strategy that will help you understand how to calculate Bollinger Bands, how you can trade with this strategy, and what its limitations are.
Good to know:
- Bollinger Bands use three lines to show if an asset is overbought or oversold.
- They indicate market volatility; a squeeze suggests low volatility, a breakout isn’t a direct trade signal.
- Calculation involves a 20-day moving average plus or minus the standard deviation.
- The strategy is simple but should be combined with other indicators for accuracy.
What you will read in this Post
What is the Bollinger Bands trading strategy?
Bollinger Bands is an essential trading tool that makes binary options trading simple, effective, and quick. With the help of this simple-to-understand tool, you can easily predict the market in a few seconds.
John Bollinger created this trading strategy. Bollinger Bands works by forming a channel around price movement. Here, the channel is based on moving price average and standard deviation.
This trading indicator is generally used for short-term trading. That’s because Bollinger Bands indicates low market volatility. Also, it gives a signal when the market starts moving.
The work of Bollinger Bands indicator is to predict the price of the market on the basis of past market data. Bollinger Bands represents data by drawing three lines after analyzing, aggregating, and calculating the past records. These three lines are known as bands.
An upper line
The upper line in the trading chart is the upper end of the predicted range. It is a result of the standard deviation plus moving average. The sum is then multiplied by a factor. Here, the upper line works as a strong resistance.
A lower line
The lower line in the chart results from standard deviation minus moving average and multiplied by a factor.
In the chart, the lower line represents the lower end of the predicted range. Also, it works as strong support.
A middle line
Lastly, you will see a middle line, which is mainline. The middle line in the chart is the moving average, and it acts as an additional barrier.
This line works as support when the market is trading below. Also, it acts as a resistance when the market is trading above.
The Bollinger lines predict three things:
- It shows whether the trading market will stay inside the outer lines or not.
- Next, it shows that when the market reaches the middle line, it will slow down. But sooner, the line will breakthrough.
- Lastly, the lines indicate that when the market moves between two lines, the movement will continue until it reaches another line.
In simple terms, the work of Bollinger Bands is to help the traders understand when the right time is to enter and exit the market. It is done by analyzing the asset- whether it’s oversold or overbought.
What do the Bollinger Bands tell you?
Bollinger Bands is one of the few popular trading techniques that both new and experienced traders can use. This technical analysis tool is still standing strong because it’s not complicated like other trading indicators.
If the price of an asset in the market is moving close to the lower band, it means oversold. Similarly, if the price is near the upper band, it indicates overbought. Additionally, when the market is less volatile, the band contracts. And when the market is more volatile, it widens.
Squeeze is one of the concepts of Bollinger Bands. Squeezing happens when bands come closer. When you notice a squeeze in the market, you can conclude that market volatility is less.
Many traders like this situation because they believe squeeze indicates future trading opportunities and increases market volatility. Moreover, if the band moves apart, it decreases volatility and offers excellent trading possibilities.
One thing you must remember is that the bands do not give any kind of trading signal. That means it’s difficult to understand when the change will take place.
The price movement of an asset takes place between two bands. That’s why when there is a breakout, it is observed as a major event.
Although breakout in Bollinger Bands is seen as a significant event, it’s not a trading signal. So, when there is a breakout, you should not rush to buy or sell assets,
How to calculate Bollinger Bands?
For calculating Bollinger Bands, you need to figure out the moving average of 20 days. The closing prices for the first 20 days are the first data point. Additionally, the next data point will be the earliest price drop, i.e., the price of day 21 and the following days.
Here’s a simple formula for calculating Bollinger Bands:
BOLU is upper Bollinger Band.
BOLD is lower Bollinger Band.
MA is moving average.
TP is typical price, i.e., (high + low + close) divided by 3.
n is the number of days in the smoothening period.
m is standard deviations.
σ[TP,n] is standard deviations of the last n period of TP.
Using this formula, you can easily calculate Bollinger Bands and use it for binary options trading.
How do Bollinger Bands work?
Here’s a quick example to understand how Bollinger Bands work:
Let’s assume that the price of fruit is $10. After a while, its price suddenly increased to $11. When the price suddenly increased, only a few people purchased it. That’s why the price of a particular fruit came back to $10.
Similarly, if the price of that fruit suddenly drops to $9, its demand will increase. The surge in demand for the fruit will again bring its price back to $10.
Through these examples, you can conclude that a sudden change in the price of an asset is temporary. That’s why there is always a slow change in the price over time.
What Bollinger Bands does is that it reflects this assumption. This trading indicator adapts dynamically to the price change in the market. The price change of assets also changes its volatility.
Here, the middle line, i.e., moving average, indicates long-term price change. On the other hand, lower and upper lines create a space where price fluctuates.
So, when the price moves towards the upper band, you can understand that the asset is getting expensive. And if it moves towards the lower band, it becomes cheap.
In short, Bollinger Bands helps in understanding market psychology. When you have a better market understanding, you make better investments.
Why should you use Bollinger Bands with Binary Options?
As you know how Bollinger Bands works, let’s see why you should use them. Here are four reasons to use this trading tool.
New trading opportunities
When the price of an asset approaches one of the Bollinger Bands, it shows how the trading market is behaving. This information can help you find new trading opportunities.
Make more money
With the help of Bollinger Bands, you can understand how far the trading market is capable of moving. When making a trade, you can further use this prediction with binary options like one-touch options and ladder options.
So, by using the predictions of Bollinger Bands, you can turn an ordinary trading opportunity into a profitable one.
Avoid bad trades
The binary options market is volatile, and it can surprise you when you are least expecting any changes. But you can keep yourself safe from making bad trading decisions.
For this, you don’t necessarily have to use Bollinger Bands. You can simply understand how different lines work in this trading tool. When you have this information, you can easily avoid bad trades.
It is simple
Bollinger Bands is a simple trading indicator that can help you do a technical analysis of the binary options trading market. You can take a quick look at the chart to understand the market through Bollinger Bands.
Not to mention that you can do the complete market analysis in just a few seconds. That’s why traders use Bollinger Bands for short-term trades.
How to trade with Bollinger Bands?
Here are three smart ways to trade binary options with Bollinger Bands:
Bollinger Bands forms a bullish breakout when the market price of an asset closes above the upper line in Bollinger. When you notice this breakout, you can opt for a call option.
Bollinger Bands forms a bearish breakout pattern when the price closes below the lower line. In this case, you can place a put option.
Bollinger Bands forms a range market when the price of an asset stays inside the range mode. If the price remains inside the range for a while, you can win a trade.
Limitations of Bollinger Bands trading strategy
While Bollinger Bands has multiple advantages, there are certain limitations as well:
- Bollinger Bands is limited to just one indicator. That means you must use this trading tool with a few other indicators for generating an accurate result.
- It does not offer well-detailed market information all the time.
Conclusion – Use Bollinger Bands for getting best results in binary options trading
Bollinger Bands is more of a tool than a trading indicator. And just like other tools, even it has some flaws. But it is one of the finest tools that you can use to understand the market’s behavior.
You can thoroughly understand the Bollinger Bands formula and what its lines represent to find better trading opportunities.
Also, to get better results, you can use Bollinger Bands with some of the leading brokers like Quotex, IQ Option, Binary.com, and RaceOption.
Frequently asked questions about Bollinger Bands in binary options trading:
What are bollinger bands in trading?
Bollinger Bands are a technical analysis tool with three lines (upper, lower, and a moving average) that indicate market volatility and potential overbought or oversold conditions.
How do you calculate Bollinger Bands?
Calculate the moving average (usually 20 days), then add and subtract the product of the standard deviation and a factor (commonly 2) from this average to get the upper and lower bands.
How can Bollinger Bands be used in trading?
Use Bollinger Bands to identify overbought/oversold conditions, gauge market volatility, spot potential breakouts, and determine range-bound markets.
What are the limitations of Bollinger Bands?
Bollinger Bands can be subjective, less reliable in highly volatile markets, and are best used with other indicators for more accurate trading insights.