Sail Dangerous Seas Safely Using Bollinger Bands (BB)

Sail Dangerous Seas Safely Using Bollinger Bands (BB)

Navigating the unforgiving seas of the financial markets can be daunting. Captains who set sails in such seas either fail to prepare for crests & troughs and sink, or use proper tools to not only survive but thrive on the ocean.

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One such tool in the market is the Bollinger Bands (BB) indicator. In this article, we’ll help you learn how to use it to your advantage. The Bollinger bands indicator was first introduced by John Bollinger in the 1980s. It was used as a gauge to monitor breakouts, and also used as a trend follower tool to predict future market movements with up to 99% accuracy.

Anyone that has been in this profession for some time knows that predicting the market with 99% accuracy is nothing short of a miracle. This indicator works similarly to a channel, but unlike classic channels downward or upward, it is a dynamic channel that can update itself automatically.

John Bollinger designed the channel in a way that its Upper Band (UB) shows where the price may go in the best-case scenario, while its Lower Band (LB) shows the price target for the worst case. To better visualize the Bollinger bands in your head, imagine yourself as captain of a ship and the price candlestick chart as the ocean tides.

candlestick chart as the ocean tides

The Bollinger bands indicator is one of my favorite tools in range market strategies. In December 2022, I made approximately $7000 sailing with this indicator. Let’s start our voyage by looking at how John Bollinger came up with it and what information it provides.

What are Bollinger Bands?

What are Bollinger Bands?

In short, Bollinger bands are where prices might go at the best or worst market scenario. In this section, I’ll teach you how the Bollinger Bands indicator came to be and what information it provides.

What are Bollinger Bands?

In the 1980s, a genius named John Bollinger swam against the tide by considering the market a random variable. He did calculations on market average, variance, and deviation (σ). As a result, the Bollinger bands indicator was born.

The Bollinger bands indicator consists of three lines, the Upper Band (UB), the Middle Line (ML) which is a Simple Moving Average (SMA 20), and a Lower Band (LB).

The lookback period length is usually set to 20 by default, though it can be changed to any other number. As a side tip, it’s a good idea to backtest the indicator length for each asset to find the best length for your Bollinger bands indicator.

the indicator length

The Bollinger bands indicator has three selectable deviations. First is the standard Deviation (D=1σ ), the default is the double Deviation (D=2σ), and finally the third is the triple Deviation (D=3σ). When you add the Bollinger bands indicator to your standard price chart, the double deviation (2σ) is selected by default. Keep in mind that the double deviation (2σ) can be replaced by the standard or triple.

When deployed, the formula adds the double deviation (2σ) to the Simple Moving Average (SMA(μ)) line, forming the upper band. It also creates the lower band by subtracting the double deviation (2σ) from the simple moving average (μ).

Based on the Normal or Gaussian distribution pattern, Bollinger stated that the standard deviation (σ) includes 70% of the future data, the double (2σ) 95%, and the triple deviation (3σ) 99%. In the trading world and in candlestick charts, this statement means that if you add the default (double) deviation (2σ), the next candle will, in 95% of the cases, form between the two bands.

form between the two bands

The price difference between the upper and the lower bands is called the Bollinger range. In 90% of cases, you will see the price range in the Bollinger range.

the price range

A professional captain prepares his ship and crew for each tide’s ups and downs. Bollinger bands, in this example, predict how high and low the water can go.

Foreseeing where the ship heads after each tide would be impossible without knowing how the water would react to each band. Is it going to continue upward? Reverse downward? Or continue sideways (range market)?

Now that you know how the Bollinger bands are calculated and what they define, we’re setting sail to the next section: learning the price behavior toward the Bollinger bands.

Further reading

How to use Bollinger Bands Indicator?

How to use Bollinger Bands Indicator?

Price reacts to each indicator differently. Learning how the price reacts to each line is the difference between money pouring into your account and losing the amount.

Unlike static channels, the Bollinger channel is dynamic and changes with each candle. So do the rules of the static channel apply to the Bollinger channel as well? Let’s take a closer look.

Let us begin with a question: if the triple deviation (3σ) contains 99% of the candles, then why do traders commonly use the double deviation (2σ)? The answer is easy; it is because you need the candles to hit and break the Bollinger bands for buy or sell signals. If the waves don’t hit the bands, it is difficult to predict where they might head next.

Returning to the captain example, Bollinger bands work like a normal static channel when the ocean is relatively calm. When the tides are going sideways, just like static channels, the waves go up and hit the upper band before going down again.

The captain knows that the tide goes down after each top, so when his ship is way up, he prepares his crew and the ship for a downward maneuver. It is the same the other way around; when the water goes down close to the lower band, the captain prepares his men for an upward maneuver. If the ship is not ready for such movements, it might get damaged or even sink.

If you add the Bollinger bands to a sideway market, you will see prices mostly ranging between the bands, breaking the Middle Line (ML) repeatedly. The Bollinger range has a stable thickness, and everything is calm and quiet.

However, sailing in ocean waters is not always that easy and predictable. Occasionally, waves grow so tall that they break static channels. In such cases, the captain needs something much more dynamic – the Bollinger bands indicator.

Bollinger Bands Indicator

When the wave (the price) goes higher and higher, the Bollinger upper band goes up while the lower band goes down, thickening the Bollinger range. When you see the Bollinger range widen like this, it signals increasing price volatility.

The Bollinger range widening occurs both in a bullish and bearish trend. The only difference is the candles’ position in relation to Simple Moving Average (SMA(μ)); they are above the SMA in upward trends and below the SMA in downward trends.

The trend slowly loses momentum and volume when it gets close to its end. Looking at the Bollinger range, it gets narrower as the trend comes to an end. This is called the Bollinger Squeeze. Although many analysts regard Bollinger squeezes as bullish signs, in actuality, they merely signal the start of a new trend which can be either bullish or bearish.

Beware that hitting the Bollinger upper band does not mean that the trend has come to an end; the price might hit or break the Bollinger upper/lower band multiple times in an upward/downward trend. As long as the waves remain above/below the middle line, the upward/downward trend continues.

downward trend continues

Previously, I mentioned that you should use the double deviation so Bollinger bands and price charts would hit and provide buy or sell signals. Next, I will explain how you can find these signals and how valid they are.

  • Bollinger Bands Signals

Bollinger bands provide traders with three types of signals:

  1. Those that form on the Bollinger bands
  2. Those that form at the middle line
  3. Divergence signals

Since opening a position against the market’s bigger trend is a gamble and has a high chance of failure, professional traders would usually rather open positions in the same direction as the market trend. The first type is usually used as exit signals for previously opened positions.

Sell signals form when the price goes up and a green candle breaks and closes above the upper band, then is followed by a red candle closing below the band. On the other hand, buy signals form when a red candle closes below the lower band, and a green candle closes above it immediately after.

The price above the middle line (SMA) favors an upward trend, but the given signal is a sell against the upward trend. These two contradict the follow-the-trend mentality. Hence, they are better used as exit signals for previously opened positions.

There is an exception to this statement, though. When you are in a range market, and the market’s overall direction is sideways, you should open positions using the first type of signals. Occasionally, bull or bear traps might form in sideways markets where Bollinger bands indicator work similarly to a static channel.

Knowing how to avoid and possibly profit from such traps is a must. My advice on opening a position in a range market is to enter positions in the direction of the trend in higher time frames.

higher time frames

The second type, signals at the middle line, is also called the Bollinger bands’ golden rule. The golden rule states that whenever the price detaches from one band, followed by a strong breakout of the middle line toward the other, it is almost certain to at least reach the other band.

Based on this principle, when the price drops from the upper band and validly breaks the moving average (μ) downward, it’s a golden sell signal. When it happens the other way around, it’s a golden buy.

the other way around

The third and last are the divergence signals. A divergence forms when the price chart and the indicator behave in contrast to each other. Divergence sell signals mostly form at the end of an upward trend, where the price chart forms a peak above the Bollinger upper band and another peak after, below the upper band.

These signals are considered negative Regular Divergences (RD-), hinting at a potential market reversal and a downward trend.

potential market reversal

On the other hand, buy signals can form with positive divergences. A positive Regular Divergence (RD+) forms at the end of a downward trend, signaling an upward market reversal.

upward market reversal

These divergences form when the price falls and create a valley below the lower band, followed by another valley above the lower band. To confirm the Bollinger bands’ divergences, I recommend you to look for divergences in other indicators like Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD).

Finding a divergence in the mentioned indicators suggests a higher probability of trend reversals. It is preferable to see such divergences at important support/resistance zones or find classic reversal or harmonic patterns on the price chart.

Now that you know how to find signals with the Bollinger bands, it is time to learn strategies to deal with them. Next, I will give you a detailed strategy for making the same $7000 as I did.

Further reading

How to trade with Bollinger Bands?

How to trade with Bollinger Bands?

Many trading strategies use the Bollinger bands indicator in combination with other indicators. The trading strategy that I will teach in this section is among the simplest ones.

The Relative Strength Index (RSI) is an indicator that highlights Overbought (OB) and Oversold (OS) areas. A common and profitable practice among traders is to combine various indicators when analyzing a chart. One such combination is combining the RSI and Bollinger bands indicators.

The strategy states that when the price chart hits the lower band and the RSI leaves the oversold area (breaks the 30% line upward), it is a strong buy signal hinting at an upward movement. As for sell signals, the price chart must touch the upper band while the RSI leaves the overbought area (breaks the 70% line downward).

To take profit from the trade in this strategy, you must use the opposing Bollinger bands’ buy/sell signals. Also, positions that are in the direction of the higher trend are preferable.

the higher trend are preferable

With this famous strategy in mind, let’s jump into my lovely memory of making $7000 using the Bollinger bands indicator.

Trade Experience

Say anything you want about Dogecoin; I profit from trading it like any other asset. As Joe Sacco said, “Don’t be indifferent when opportunity knocks at the door; just invite it in.” That day, the opportunity presented itself in the Dogecoin chart. I added the Bollinger bands indicator to the Dogecoin 15-minute chart (DOGE/USDT) when it was on a downward trend in December 2022.

I watched the price go down, head back up and pivot in a resistance zone. While in the resistance zone, a green candle closed above the upper Bollinger band, followed by a red candle that closed below the upper band. I had my Bollinger bands sell signal.

I entered my first short position afterward at 0.07608 USDT and placed my stop loss price above the mentioned green candle at 0.07650 USDT. As for my take profit, I used a Bollinger band buy signal to close my first short position at 0.07548 USDT.

A while later, I noticed several green candles pushing the price high and widening the Bollinger range. The price went up, and a shooting star reversal candlestick pattern touched the downward trend line(above the upper band). I had my sell signal, so I opened my second short position at 0.07560 USDT. I don’t like taking risks, so I set my stop loss at 0.07620 USDT.

Just like my first take profit, I took my second profit with another Bollinger band buy signal at 0.07470 USDT and, overall, made more than $7000 in a single day. I probably could have stayed in the trade for longer and exited the market with bigger bags, but I’m a simple man – I’ll take the seven thousand dollars a day offer at any time.

seven thousand dollars

Further reading
FAQ

FAQ

What are Bollinger Bands?

Bollinger bands are two lines of an indicator with the same name that shows the deviation (σ) of the price chart data from its average (μ). It was designed by John Bollinger in 1980, as a tool that could predict future market movement with up to 99% accuracy.

How to calculate Bollinger Bands?

To calculate Bollinger bands you first need a price average (μ) line. Then you must add the price data deviation (σ) to the average (μ) line to find the upper band and subtract it from the average (μ) to find the lower band. The lookback length is also important; you must backtest it to find the right length for each asset. The default length is usually set to 20.

What do Bollinger Bands show?

The Bollinger bands show to what price the next candle can pump or dump the price at the best or worst-case scenarios. The Upper Band (UB) shows the best upward price target possible and the Lower Band (LB) shows the lowest price target.

How to use Bollinger Bands?

Bollinger bands indicator is used both as a trend follower indicator and a signal provider indicator. When the Bollinger range between the two bands starts to widen, it signals an increase in the price volatility.

The Bollinger squeeze, on the other hand, hints at a decrease in the volatility. It also gives buy/sell signals when the price chart breaks the lower/upper band down/upward, but immediately after, the bands catch up with the price.

How to trade with Bollinger Bands?

To trade with the Bollinger bands indicator, you either must use its signals to open positions in the direction of the higher market trends or use them as exit signals to exit already opened positions. You also can combine the Bollinger bands with other indicators such as the Relative Strength Index (RSI) indicator.

Conclusion

Conclusion

In this article, you learned about what the Bollinger bands indicator is and how you can use it to make profitable trades. After reading this article, you should be ready to sail in the wild seas, survive, and thrive by using the Bollinger bands indicator to foresee what comes next.

You learned that, unlike any other indicators, the Bollinger bands indicator has the potential to predict upcoming waves with up to 99% accuracy. Although advanced trading platforms like tradingview do all the math, you learned what these equations mean and what data they show.

You also learned how you can find buy and sell signals using the Bollinger bands indicator and how you can filter the weaker ones by considering the higher trend and adding other indicators. With proper strategy, you learned many lessons from my trading experience that granted me $7000 in a single day.

And finally, our voyage has come to an end, captain! It is time for you to set sail to the wild ocean and thrive using your own customized strategy. My parting note to you is that, as always, you should make sure to practice your strategies and always have your seatbelts (stop loss) on. As Charles Melville Hays once said, “Safety first is safety always.” Stay safe, and happy sailing!

Further reading