Bollinger Bands

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Developed by John Bollinger, Bollinger Bands measure market volatility and provide a wealth of useful information, such as:

  • Trend continuation or reversal
  • Market consolidation phases
  • Upcoming high volatility periods
  • Potential market tops or bottoms, and price targets

Bollinger Bands – Explanation

Bollinger Bands consist of three bands, with two of them revolving above and below a central simple moving average, thus engulfing the price.

In the default settings, the number of periods over which the central simple moving average is calculated is 20, while the number of standard deviations is set on 2, defining the values of the upper and lower Bollinger Bands.

It turns out that with this type of settings, statistics show that 95% of the price should remain within these bands.

Calculation of the Bollinger Bands indicator formula

  • Calculation of the central simple moving average over N periods, usually 20 days:
  • MA = Sum of the closing prices over the last 20 periods divided by the number of periods
  • Value of the upper band:
  • Here, we add 2 standard deviations to the value obtained for the 20 period simple moving average
  • Value of the lower band:
  • Here, we remove 2 standard deviations from the value obtained for the 20 period simple moving average

You can test Bollinger Bands in the stock market with a demo trading account.

How to interpret Bollinger Bands?

Bollinger Bands interpretation

Bollinger Bands can be interpreted in different ways depending on their behavior. Indeed, we can observe different phases depending on whether the market is in range or in trend.

Since the bands represent market volatility, the larger the gap between the bands, the more volatile the market is.

This makes it possible to identify volatile situations and therefore, periods when there is little volatility on the financial asset. Remember that 95% of the price normally remains within the Bollinger Bands.

This implies that when the price breaks the upper or lower band, there is a good chance for the price to return inside the bands on the following candles. Nevertheless, when the market is in trend, the exact opposite happens and some traders even use these breaks to take position.

In periods of strong movement the bands deviate more than usual, while in periods of range the process is reversed, and we observe a tightening of these same bands, informing us of the context of the market in which we operate at that precise moment.

For a technical analyst trader, trading near the outer bands provides an element of confidence that there is resistance (upper band) or support (bottom band), however, this alone does not provide relevant buy or sell signals; all that it determines is whether the prices are high or low, on a relative basis.

Given this information, a trader can enter either a buy or sell trade by using indicators to confirm their price action. Remember, the action of prices near the edges of such an envelope is what traders are particularly interested in.

The Bollinger Bands technical indicator can be applied to any financial instrument from any market. As mentioned above, using a period of 20 as the default setting for all markets is recommended, although this period can be modified when market conditions require it.

As you lengthen the number of periods over which you want the indicator to be calculated, you need to increase the number of standard deviations employed. At 50 periods, two and a half standard deviations are good, while at 10 periods; one and a half do quite well.

50 periods with 2.5 standard deviations

10 periods with 1.5 standard deviations

Upper band = 50 period SMA + 2.5 (S)

Upper band = 10 period SMA + 1.5 (S)

Middle band = 50 period SMA

Middle band = 10 period SMA

Lower band = 50 period SMA - 2.5 (S)

Lower band = 10 period SMA - 1.5 (S)

To put it simply, the free MT4 and MT5 Bollinger Bands indicator corresponds very well with these market conditions:

  • Ranges, when there is a good chance of a return to the inside of the envelope after a test or a break of it
  • Trends, when the market breaks the external boundaries providing a forex trading signal

Identify the trend with Bollinger Bands

If Bollinger Bands widen from the middle simple moving average (SMA), the slope of the bands will follow the central simple moving average's one, thus going up in a bullish trend and down in a bearish trend. Trend phases are most of the time initiated by the breakout or breakdown of the previous range materialized by a candlestick's closure above or below one of the two outer bands.

Identify ranges with Bollinger Bands

When prices are in range moving sideways, Bollinger Bands narrow around the middle simple moving average (SMA), and the slope of the central simple moving average remains quite neutral. This illustrates a price consolidation, with rebounds on the low and high bands of John Bollinger's indicator.

How to use Bollinger Bands?

Tips for trading well with Bollinger Bands

  • Bollinger Bands indicate whether volatility is high or low
  • Volatility and trend are already taken into account in the construction of Bollinger Bands, so using them as price confirmation is not recommended
  • It is not useful to use several indicators from the same family (such as two oscillators or two momentum indicators)
  • Prices can exceed the upper band and go below the lower Bollinger Band
  • Closures outside Bollinger Bands are continuation signals, and not reversal signals
  • The displayed simple moving average is not the best for trend changes. On the contrary, it indicates the medium/long term trend
  • Bollinger Bands are based on a simple moving average. This is because a simple moving average is used in the standard deviation calculation, and it is good to be logically consistent
  • If the number of periods is lengthened, the number of standard deviations needs to be increased simultaneously; from 2 at 20 periods to 2.5 at 50 periods. Likewise, if the number of periods is shortened, the number of standard deviations should be reduced; from 2 at 20 periods to 1.5 at 10 periods

Bollinger Bands – MT4 & MT5 trading platforms

The Bollinger Bands indicator is a technical indicator widely used by investors and traders. The main trading platforms and most online brokers offer this indicator on their online trading software. You can therefore find this indicator on:

  • MetaTrader 4
  • Metatrader 5
  • WebTrader MetaTrader

Bollinger Bands strategies

You can use Bollinger Bands:

  • As your main technical trading indicator when scalping (short-term trading)
  • In a strategy with another indicator such as the AdmiralKeltner indicator

Bollinger Bands day trading strategy

Ms. Kathy Lien, a well-known forex analyst, and trader, described a very good technique for using Bollinger Bands in an indicator's combo, called the DBB strategy: the "Double Bollinger Bands" strategy. In her book "The Little Book of Currency Trading", she wrote that this was her favorite method.

Originally, the DBB strategy can be applied when performing technical analysis on any financial asset exchanged on a liquid market such as the forex, the equity, the commodity, or the bond market.

Here is how you apply it to your chart:

  • 1.Insert the Bollinger Bands indicator on your chart
  • 2.Go to the "Bollinger Bands properties", and select a standard deviation of 2 and a period of 20

Source: Admiral Markets Platform – Settings for Bollinger Bands

  • 3.Insert a second set of Bollinger Bands with a different color
  • 4.Go to the "Bollinger Bands properties", and select a standard deviation of 1 and a period of 20

Source: Admiral Markets Platform – Settings for Bollinger Bands

Once the indicators have been correctly applied to the chart, the following areas should be observed:

Source: GBP/JPY H4 Chart – Admiral Markets Platform – Data range: July 10, 2017 – August 18, 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

  • A1: The upper BB (Bollinger Band) line that is two standard deviations away from the X line, which is the 20 period simple moving average (SMA)
  • B1: The upper BB line that is one standard deviation from the 20 period simple moving average (SMA)
  • X: The 20 period simple moving average (SMA). This serves as both the center of the DBBs and the baseline for determining the location of the other bands
  • B2: The lower BB line that is one standard deviation from the 20 period simple moving average (SMA)
  • A2: The lower BB line that is two standard deviations from the 20 period simple moving average (SMA)

These bands represent four distinct trading zones used by traders to carry out their transactions.

Source: GBP/JPY H4 Chart – Admiral Markets Platform – Data range: July 10, 2017 – August 18, 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

  1. The buy zone is located between the A1 and B1 lines
  2. The neutral zone 1 is located between the B1 and X lines
  3. The neutral zone 2 is located between the X and B2 lines
  4. The sell zone is located between the B2 and A2 lines

According to the main theory behind the DBBs, Ms. Kathy Lien described that we should combine the two middle areas, and then focus on three zones:

  1. The upper quarter
  2. The middle half
  3. The bottom quarter

The DBB buy zone:

When the price is in the upper zone (between the two upper lines, A1 and B1), it indicates that the bullish trend is strong and that the price is more likely to continue to rise. As long as candlesticks continue to close in the upper quarter, current long positions should be maintained, and new ones can even be opened.

The DBB sell zone:

When the price is in the bottom zone (between the two lowest lines, A2 and B2), the bearish trend is more likely to continue. This tells us that as long as candles close in the lowest zone, a trader should maintain current short positions, or even open new ones.

The DBB neutral zone:

When the price gets within the area defined by the one standard deviation bands (B1 and B2), there is no strong trend, and the price is likely to fluctuate within a range because momentum is no longer strong enough for traders to continue the trend. The 20 period simple moving average (X) that serves as the baseline for Bollinger Bands is in the center of the zone.

Source: GBP/JPY H4 Chart – Admiral Markets Platform – Data range: May 11, 2017 – June 23, 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

When to trade with the DBB strategy – Bollinger Bands strategy

According to the rules, whichever zone the price is in will signal whether you should be trading in the direction of the trend (long or short), depending on whether the trend is bullish or bearish. Basically, if the price is in the upper zone, you should be looking for long opportunities, and if it is in the lower zone, you should be looking for short opportunities.

If the price is in the two middle quarters (the neutral zone), you should restrain from trading (if you're a pure trend trader), or trade shorter-term trends within the current trading range. Usually, traders trade higher time frames or operate on a daily basis with this strategy.

Bollinger Bands scalping strategy

This Bollinger Bands scalping strategy requires 5 indicators which are attached to the chart below:

  • The Bollinger Bands indicator - (14.1), green
  • The Admiral Markets Pivot indicator - (H1)
  • The Bill Williams' Awesome oscillator
  • The Relative Strength Index (RSI) - (14)
  • An exponential moving average (EMA) - (4), red

The time frames for trading this forex scalping strategy are either the 1-minute, the 5-minute, or the 15-minute time frames. The targets are the pivot points defined over the 1-hour time frame by the Admiral Markets pivot indicator. The stop loss is placed below the intermediate pivot support for a long position, or above the intermediate pivot resistance for a short position. This trading strategy is mainly designed to trade major currency pairs.

Long position:

Source: EUR/USD – Admiral Markets Platform M5 Chart – Data range: August 18, 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

A buy position is triggered when the 4 period exponential moving average (EMA) crosses up through the middle Bollinger Band, at the same time that the Awesome oscillator crosses up through the 0 line, and that the RSI crosses up through the 50 line.

Short position:

Source: EUR/USD – Admiral Markets Platform M5 Chart – Data range: August 17-18 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

A short position is triggered when the 4 period exponential moving average (EMA) crosses below the central Bollinger Band (the 20 period simple moving average), at the same time that the Awesome oscillator passes below its 0 line, and that the RSI crosses below the 50 line.

The Bollinger Bands & Admiral Keltner strategy

This strategy uses two technical indicators applied to the chart:

  • The Bollinger Bands indicator
  • The Admiral Markets Keltner indicator

For Bollinger Bands and the Admiral Keltner indicator, the default settings should be used on the vast majority of trading platforms:

Bollinger Bands: 20 periods, 2 standard deviations

Keltner Canal: 20 periods

There are many Keltner channel indicators freely available on the internet. Moreover, it has been noted that there were many different versions of the indicator itself. However, only two versions are commonly used. The Admiral Keltner indicator is one of the best (and free) versions of the indicator in the market, mainly because the bands are derived from the Average True Range indicator (ATR).

You should not only be sure that you're using the formulation that uses the Average True Range, but also that the center line is a 20 period exponential moving average. The Admiral Markets Keltner indicator has all the settings correctly set in the indicator itself, and should look like this:

Source: Admiral Keltner Indicator

Understanding this element is the key to understanding how the Bollinger Bands indicator detects and displays fluctuations in the degree of volatility. The number of standard deviations is determined by the difference between the current closing price and the average closing price.

The general concept is that the further away the closing price is from the average closing price, the more volatile the market is considered to be and vice versa. This determines the degree of contraction or expansion of the bands.

Source: GBP/JPY H4 Chart – Admiral Markets MetaTrader (MT4) Platform – Data range: June 16, 8:00 PM 2017 – Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

On the above stock market chart, at point 1, the blue arrow indicates a compression. At point 2, the blue arrow indicates another compression. This is also the case with point 3.

The difficulty in this situation is that we still don't know if the compression is a valid breakout. Then, what needs to be done is to quantify how narrow the squeeze (compression) should be in order to confirm and quantify compressions. To do this, the Keltner Channel indicator will be used.

Therefore, the Keltner channel is added to the chart below:

Bollinger Bands = Green

Keltner channel = Red

In the Japanese candlestick chart above, we have the Admiral Keltner Channel indicator overlaid on top of what you saw in the first chart so that we can start looking for proper compression. You should only trade configurations that meet the following criteria (as shown in the chart below):

Source: GBP/JPY M30 Chart – Admiral Markets MT4 Platform – Data range: March 10, 6:30 PM 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

  • 1.Only trade when both Bollinger Bands exit or re-enter the Keltner Channel simultaneously. That is the only "proper way" to trade with this strategy
  • 2.The yellow highlighted areas show examples of Bollinger Bands (green lines) going inside the Keltner Channel (red lines)
  • 3.In these areas, compression has started
  • 4.When the bands (the two green lines) begin to come out of the Keltner Channel (red lines), the compression has been released, and a price movement is imminent
  • 5.Wait for a buy or sell signal before opening any position

The Bollinger Bands and Keltner Channel indicators inform you when a market is moving from low to higher volatility. The joint use of these two indicators is more effective than the use of a single indicator, and both should be used together.

When to trade with Bollinger Bands

Source: GBP/JPY M30 Chart – Admiral Markets MT4 Platform – Data range: March 10, 6:30 PM 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

Buy position: When a compression is formed, wait until the upper Bollinger Band crosses through the upper Keltner channel, and then wait for the price to break and close above the upper band to go long.

Sell position: When a compression is formed, wait until the lower Bollinger Band crosses through the lower Keltner channel, and then wait for the price to break and close below the lower band to go short.

Another example is illustrated below. After the compression and release happened, remember that you need to wait for the candle to close above or below the Bollinger Bands to enter the position.

Source: GBP/JPY M30 Chart – Admiral Markets MT4 Platform – Data range: February 23, 00:00 AM 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

In the example above, we can also see that there was no entry after the release because there was no breakout to confirm the trade's entry.

The recommended time frames for this strategy are the 30-minute and the daily time frames. The strategy can be applied to any financial instrument. Day trading breakout is mainly conducted on 30-minute and 1-hour charts. You can use the Admiral Pivot indicator to place stop losses and take profits.

The stop loss for long positions can be placed 5 to 10 pips or points below the central Bollinger Band (the 20 period simple moving average), or below the closest Admiral pivot point support, while the stop loss for short positions can be placed 5 to 10 pips or points above the central Bollinger Band, or above the closest Admiral point pivot support.

Target levels are calculated with the Admiral Pivot indicator. For 30-minute and 1-hour charts, daily pivots are used whereas for 4-hour and daily charts, weekly pivots are used. Both settings can be changed easily within the indicator itself.

Source: EUR/USD M30 Chart – Admiral Markets MT4 Platform – Data range: June 16, 10:00 PM 2017 – Please note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.

The Bollinger Bands indicator is an essential technical analysis tool in trading. Its creator John Bollinger, an American financial analyst, uses this indicator to represent the level of volatility in the market.

Trend trading with Bollinger Bands

Trend traders will favor price exits beyond Bollinger Bands in order to catch range breaks and take advantage as soon as possible of the new trend that is emerging.

Whether bullish or bearish, the closure of a candlestick outside the bands can indicate an impulse and the resumption of volatility.

Similarly, most conservative traders expect a first wave of momentum visible through the bands before waiting for a correction to find a more conservative trading opportunity, this time waiting for a test of the lower band in the case of a bullish trend and the upper band in the case of a bearish trend.

Range trading with Bollinger Bands

Range traders, on the other hand, favor rebounds on the high and low bands. Thus, when the conditions for range trading are met, the range trader who uses Bollinger Bands will take advantage of the rebounds on the top of the range and will aim for the middle and bottom of the range. Once arrived at the bottom of the range, he will take an opposite position to aim for the middle and top of the range.

It is important to note that in a range market, the upper and lower bands of the indicator become synonymous with the resistance and support between which the range evolves.

In the end, the MT4 Bollinger Bands indicator facilitates the analysis of market trends and ranges. These Bollinger Bands techniques are widely used and practiced by retail and professional traders.

How to use Bollinger Bands in trading

Whether you are using Bollinger Bands to analyze the forex market or any other financial market, the way to use the indicator remains the same. Candlestick patterns can also be used as a complement to filter out potential false trading signals delivered by Bollinger Bands. Therefore, depending on whether you are trading ranges or trends, a good understanding of Japanese candlesticks is essential.

In the case of ranges, the best moments to get into the market is at the extremes of this range. In the case of trends, the best times to buy or sell the financial asset is when the price breaks above or below the bands.

Advantages and limitations of the MT4 Bollinger Bands indicator

Advantages:

  • Identifies ranges
  • Identifies trends
  • Allows you to monitor market volatility
  • High reactivity according to market conditions

Limitations:

  • Does not take into account the volumes exchanged, as there is no weighting of the price with its volume.

Bollinger Bands trading – Conclusion

Bollinger Bands is undoubtedly one of the favorite indicators for technical traders. The best way to create an opinion about it is to test it on one of our free demo trading accounts, in real conditions.

What results can be obtained with Bollinger Bands?

Remember that no indicator can be used on its own, and must be part of a broader and more comprehensive system. Other information needs to be gathered in order to put all the chances of success on your side. Your results depend on your capital, your analysis, your psychology, and money management. Bollinger Bands is a tool and not an objective. They can help you identify market trends and volatility.

About Admiral Markets

As a regulated broker, we provide access to some of the most widely used trading platforms in the world. With us, you can trade CFDs, shares, and ETFs.

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