Bollinger Bands is a popular technical analysis tool. They consist of two trendlines plotted as positive and negative deviations from an asset’s simple moving average (SMA). By showing price volatility, they help traders identify potential overbought or oversold conditions.
While creator John Bollinger cautioned against using them as absolute buy or sell signals, Bollinger Bands remains a versatile tool for various trading strategies, including binary options. This guide explores their structure and strategic use in trading.
Key Facts About Bollinger Bands Strategy:
- Bollinger Bands consist of three lines: the simple moving average (SMA) in the middle and two standard deviation-based bands above and below.
- They help traders identify overbought and oversold conditions by tracking volatility, making them useful for various strategies, including binary options.
- A key strategy involves analyzing price behavior near the bands—if prices frequently touch the upper band, it may signal overbought conditions; similarly, touching the lower band can indicate oversold conditions.
- Traders often combine Bollinger Bands with other indicators, like the RSI or MACD, for more accurate trading signals.
What Are Bollinger Bands? And How Is It a Strategy?
Bollinger Bands is a technical analysis tool that gives traders overbought or oversold signals.
Bollinger Bands is a set of three lines: the simple moving average (the middle band), an upper band, and a lower band.
The upper and lower bands are usually around 2 standard deviations removed from a 20-day SMA, and traders can modify the extent of deviation as best suits their desired analysis and trading strategy.
When a security’s price continually touches the upper Bollinger Band, this can generate an overbought signal, and if the price continually touches the lower band, this can signal the security’s oversold status.
Bollinger Bands are ubiquitous chart indicators for technical analysis, and many different types of traders in a myriad of markets employ them. Since they were developed by Bollinger in the 1980s, they have consistently provided traders with more accurate insights into an asset’s price and related volatility.
Bollinger Bands do more than signal overbought and oversold levels. They’re an ideally designed trend-following tool, and because of their architecture, they inevitably aid breakout strategists, too. Intrinsically, Bollinger Bands measure deviation, which is why any trader following trends employs them religiously.
How To Calculate The Bollinger Bands Indicator
The Bollinger Bands indicator can be set up on most trading platforms (like MT4) with a few clicks, but it’s essential that traders also have a basic understanding of how it’s calculated.
Bollinger Bands calculates by computing a security’s simple moving average (SMA), which typically uses a 20-day SMA. The SMA will use the closing prices from the first 20 days as its first data point.
The next data point will drop the earliest price, add the price on day 21, compute the average, and so on.
Now, the standard deviation of the security’s price will be gleaned from a mathematical calculation (the measurement of average variance): this pegs a standard deviation that will determine the upper and lower Bollinger Bands.
Technically, the standard deviation measures how far numbers are from the average value for any given data set. Standard deviation is calculated by taking the variance’s square root, the variance itself being an average of the squared differences of the mean.
Finally, the standard deviation value is multiplied by two; that amount is added and subtracted from each data point along the SMA. This produces the upper and lower Bollinger Bands.
Written as a simplified formula, Bollinger Bands look like this:
Upper Bollinger Band = 20-day SMA + (20-day SD x 2)
Middle Bollinger Band = 20-day SMA
Lower Bollinger Band = 20-day SMA – (20-day SD x 2)
In a nutshell, the Bollinger Bands will give you a market view based on recent events, where an asset sits now, and, thus, how to interpret current price action.
How To Trade Binary Options with Bollinger Bands
- Choose a trading platform (Pocket Option or Quotex are good options).
- Add the Bollinger Band indicator to your charting.
- Make your analysis.
Strategies for the Bollinger Band indicator:
Bollinger Bands’ ability to adjust to volatile market conditions makes them a crucial technical indicator for binary options trading.
When employing Bollinger Bands, volatility swings and fluctuations in an asset’s price become known aspects of a calculation before entering trades. When volatility dips, Bollinger Bands squeeze toward each other (known as consolidations in options trading).
When an asset’s price breaks out, and the markets experience renewed volatility, traders can determine new price trends and place calls or puts accordingly.
How does that extrapolate into strategy? Looking at the strategies below, it becomes easier to see where and how Bollinger Bands aid binary options traders.
60-Minute Bollinger-Momentum Strategy
This 60-minute binary options trading strategy combines Bollinger Bands with a momentum determinant to signal trading.
Here, traders set the charting time frame to 15 minutes, and the expiry time (when the trade is closed out) is 60 minutes (thus producing a 4-candle expiration).
Set the Bollinger Bands to default (a 20-day SMA) and set the momentum indicator to 11 periods (it’s 12 by default, so adjust it).
If you’re looking to buy a call option (price going up), you’ll need the price to move above the SMA and the momentum indicator to be above its 100.00 level.
If you’re looking to place a put option (prices dropping), you’ll want to see the security’s price dip below the SMA while the momentum indicator is below its 100.00 level.
For this strategy to consistently generate wins, both preconditions for a call or put trade must be met. If the price crosses the SMA but momentum is out of sync, don’t trade and expect to win.
Both preconditions must be met to indicate a strong chance of successful trading, whether with a call or put option.
60-Second Bollinger Strategy
This strategy best suits the scalpers of the binary fraternity, as it’s a fast-paced strategy with which you can enter trades based on price position outside of the Bollinger Bands.
With the time frame set to 1 minute, set the Bollinger Bands indicator to its default (a standard 20-day SMA for the middle band, and the upper and lower being two standard deviations from the middle average).
With this strategy, the expiry time is 5 minutes. Call options should be bought when you see oversold conditions.
Specifically, when the asset’s price breaks below the lower band, you can anticipate a bounce back to within the two bands.
Using candlestick reversal patterns as confirmation and waiting for an initial move towards ‘back between the lines’ means a positive signal for a buy order.
Similarly, when you spot overbought conditions (the price breaks above the upper band), touch and return may be imminent. Again, candlestick reversal patterns are useful confirmation, and once an initial move back within the bands is noted, a put option should win.
You can further narrow the risk by limiting the trading segment using the Average Directional Index (ADX), and the ADX should be at or below its 20.0 level to be valid confirmation.
Bollinger Breakout Strategy
Although breakouts (prices escaping the Bollinger Bands) are viewed as significant in trading, don’t mistake breakouts as automatically indicative of the market’s pursuit of new price levels.
While the strategy above trades on a (candlestick-confirmed) return to the legacy price range, breakouts trade on a moment of adventure, where prices will remain out of the usual confines long enough to indicate a search for new price levels.
This strategy is ideally supported by thorough research and, specifically, news that lends credence to the possibility of new price levels (bad news, prices correct downwards, good news, prices find new buoyancy).
A bullish breakout (prices close above the upper Bollinger Band) can be a good entry signal for a call option trade. Ideally, there is supporting confirmation (news, recent frequent breakouts on the asset that lingered) to support a quick call option trade.
Bollinger Bands can denote a bearish breakout (the asset’s price closes below the lower band) and, again, supported by other indicators; this can be an opportunity for a put option trade that wins.
Bear in mind that prices are as likely to return to range (i.e., bounce back in between the Bollinger Bands) as any other scenario, hence the need for additional confirmation from other indicators that the breakout will be sustained, even if it’s only for a moment.
What Are The Pros and Cons of the Bollinger Bands Indicator for Binary Options?
Bollinger Bands are visually great for detecting high and low volatility moments and often (for binary options traders) switching between a few selected strategies accordingly.
That said, every indicator has its limitations, and you should be aware of the pros and cons of Bollinger Bands and how they might affect your trading.
- Visually easy to identify the start and end of volatility, thus positioning you for near-term breakouts (enabling volatility plays)
- This narrows risk while also delimits potentially profitable moments and arenas where profit can be made
- While it might seem of no concern, Bollinger Bands nonetheless consistently denote new trading opportunities and, especially in flat sideways markets, the bands can be the first indicators of change
- Their value is further extrapolated by the fact that Bollinger Bands show just how far markets are capable of moving, especially useful for traders employing one-touch (and even ladder) binary option trades
- Bollinger Bands are simple to use and understand, not only because of their visual architecture but mathematically too
- Ranging market strategies are well served by Bollinger Bands, as the upper and lower limit containment work like clockwork
- Finally, Bollinger Bands let you avoid terrible trades, as they are a basic, unambiguous indicator that spells either good or bad news in short order
- Bollinger Bands are a single indicator, and although their beauty is in their simplicity, that simplicity has to be aided by multiple other indicators/data points for binary traders to narrow risk
- Bollinger Bands won’t offer detailed market intel at every turn when you’re looking to trade; indicators will rise to prominence from time to time depending on what’s happening in the markets, your preferred strategy, and your attempts to limit risk
- Bollinger Bands are computed from the SMA, which means that the upper and lower bands are weighing dated data being as relevant as the most recent data, thus potentially diluting new information with outdated information
- The fact that Bollinger Bands employ a 20-day SMA and two standard deviations will not suit every trader for every purpose, and you should monitor how well that architecture is doing for your strategy and adjust things accordingly (their default settings are pretty arbitrary)
- Bollinger Bands are reactive, not predictive (they’re a lagging indicator that can’t predict price movements)
What Are Alternatives to the Bollinger Band Indicator?
1. MACD
The moving average convergence/divergence (MACD) follows trends as a momentum indicator. It displays a relationship between two exponential moving averages (EMAs) of an asset’s price.
The MACD line is generated by subtracting the 26-period EMA from the 12-period EMA.
The 9-day EMA of the MACD line is known as the signal line, and when it’s superimposed on top of it, it can indicate buy or sell signals.
MACD lines are particularly useful when looking for divergences, crossovers, or very quick market rises and falls.
Best employed in legacy daily periods (24/12/9), MACD lines give indications of a security’s overbought or oversold status, the strength of a directional move, and the potential for a price reversal.
2. CCI
The commodity channel index (CCI) is a development of technical analyst Donald Lambert. Introduced in the 1980s, it is an oscillator that performs very similarly to other oscillators in this category.
This linear oscillator, which identifies oversold or overbought market periods, resembles the RSI (below) but also has distinct differences.
The CCI indicator clearly shows when the current price levels are high, above, or far below the moving average (MA). You’ll set your MA periods, and the CCI oscillator line clearly shows strong uptrends or downtrends.
When the CCI exits this range, it typically oscillates between levels +100 and -100, which traders can interpret as an overbought or oversold signal.
3. RSI
The relative strength index (RSI), like the MACD, is a momentum indicator.
The RSI is a component of technical analysis. It measures the speed and magnitude of an asset’s recent price movements.
This allows traders to evaluate under or overvalued price conditions, leading to more successful entry points and winning trades.
The RSI is another line graph (oscillator) running on a scale from zero to 100. Developed by J. Welles Wilder Jr. and publicized in his 1978 book, New Concepts in Technical Trading Systems, the RSI is now a standard component of myriad traders’ technical analysis.
Working best in range trading rather than following trends, the RSI allows technical traders to glean signals about bullish (or bearish) price momentum.
Can you combine the Bollinger Band with other indicators?
Yes! John Bollinger himself advocated using several indicators in conjunction with his bands to sharpen trading accuracy.
By combining Bollinger Bands with other indicators, you’ll make better decisions about entering trades and better entries into those trades.
A potent combination of Bollinger Bands, the RSI, and the MACD will satisfy most traders’ need for broad but sufficient technical analysis, with finer touches being a last matter of personal preference.
Bollinger suggested that the bands be employed to ascertain volatility but in conjunction with two or three other indicators that give sharper market signals.
While Bollinger Bands are indispensable for pointing to the market’s value price areas, they won’t indicate the price strength or weakness of those areas; hence, the value of combining Bollinger Bands with oscillators.
For example, if a security’s price is trading close to the upper Bollinger Band, yet the RSI is displaying bearish divergence, you can conclude that there is definite price weakness and place your sell orders.
Conclusion
Traders are mercenaries, and justifiably so, because the markets are merciless. Only tools that provide genuine value and truly aid traders will become commonplace.
Although Bollinger Bands can be seen as broad indicators denoting a good trading direction, many traders use them as sharper tools, developing strategies that employ Bollinger Bands as their primary trade determinant.
Bollinger Bands have earned their place among the top tier of technical analysis tools for these reasons, and few (even niche) traders can afford to ignore them completely.
Most commonly asked questions about Bollinger Band strategy for binary options:
Will Bollinger Bands guarantee successful binary trades?
No. Bollinger Bands will narrow risk and aid, just like other technical data points, to binary options trading, but especially in a yes/no trading construct, nothing is guaranteed.
What is the principal benefit of Bollinger Band analysis in very quick binary trading strategies?
Bollinger Bands clearly shows just how far markets can move. When you’re trading binary options types with high payouts (ladder options, one-touch options), you need this information to trade successfully. Indeed, it’s hard to imagine any consistently successful binary options trader doing without Bollinger Bands’ analysis.
Do I have to use Bollinger Bands in binary trading?
Bollinger Bands can be viewed as an ‘arm’s length’ tool, getting you in the right direction as you approach an options trade. They can also often be the clincher right when placing a trade. Still, they are always at least very useful indicators, and the vast majority of binary options traders (and almost every other kind of trader) employ Bollinger Bands in their charting.
