In this article we focus on professional configuration of the popular Bollinger Bands indicator.
Bollinger Bands calculation
Bollinger Bands are formed by three lines. The middle line is a simple moving average. It is used to calculate a relative definition of high and low prices of the market. This is what a mathematical formula for constructing Bollinger Bands looks like:
BB = MA ± k * StdDev
MA — moving average;
StdDev — standard deviation;
k — standard deviation coefficient.
The standard deviation StdDev is calculated as:
StdDev = SQRT (SUM ((CLOSE – SMA (CLOSE, N))^2, N)/N)
Where N is a number of periods which are used to calculate the simple moving average (for example, 20 candles), and SQRT is a square root.
When constructing Bollinger bands, one usually uses the standard deviation coefficient k which is equal to 2. At this value, 95% of all prices fall within the price range, which is limited by the bands.
To calculate the standard deviation value, you should select the calculation period. As a rule, they use the same value as for the smoothing coefficient of the moving average.
The recommended period for Bollinger Bands is from 13 to 24 (20 is the most common one). The deviation is usually chosen within the range from 1.5 to 5, and the recommended value is selected from 2 to 3.
You can also use Fibonacci numbers, round numbers 50, 100, 150, 200 and the number of days in the trading and calendar year (240, 365). But remember that large periods reduce the sensitivity of the indicator, which is unsuitable in low volatility markets.
The price mostly moves within the channel, but it can also cross Bollinger Bands in case of a sudden movement. However, if the price crosses the upper or lower band too often, you should increase the period, and if the price rarely reaches the outer bands, the period should be reduced.
Price and Time Frame
Closing prices are mostly used for the calculation of Bollinger Bands. Average or weighted average prices can also be used.
Bollinger bands work well on any timeframes, but, as a rule, they are used for day trading. Remember that the settings for different currency pairs and different timeframes should be selected separately.
The main signals of the indicator
- Trade the middle band.
If the price crosses the middle band upwards, it is a bullish signal. If the price crosses the middle band downwards, it is a bearish signal.
- Trade after the price returns into the channel.
The position should be opened against the leaving point of the indicator band. Wait for the candle / bar to be closed inside the indicator and open the position towards the middle band. Logically, the entry point is similar to the standard entry point for oscillators.
- Use the outer bands.
The bands are adjusted so that they form dynamic levels of support / resistance for the current price movement. When it approaches the upper level of resistance, you can sell, and when it approaches the lower level of support, you can buy.
John Bollinger himself notes the following features of his indicator:
- Sharp price changes usually occur after the band narrows, which means a decrease in volatility.
- If peaks and bottoms outside the band are followed by peaks and bottoms within the band, a trend reversal is possible.
- Price movement that starts at one side of the band usually reaches the opposite side. This observation is useful for predicting price benchmarks.
Remember that the professional setting of Bollinger Bands of any indicator requires deep knowledge and good trader training. Take part in Olymp Trade training webinars and trade with confidence!