Common uses of Bollinger Bands

The Bollinger Bands is a technical analysis tool developed by John Bollinger in the early 1980s.

Bollinger bands consist of three curves drawn in relation to the price. These three curves are the upper band, the lower band and the middle band. The middle band is, as a rule, a simple moving average and therefore provides information on the trend. From the midband the upper and lower bands will be calculated using a standard deviation. The interval between the upper and lower bands gives information on the volatility or market activity. By default, the parameters used are a simple moving average of 20 periods and 2 standard deviations to calculate the upper and lower bands. 

(Note: on some platforms and graphical analysis software the midband is not shown). 

Image 1: Bollinger Bands with standard configuration. MT4 of Z.Com Trade
This is because the standard deviation can be interpreted as a measure of volatility, therefore when the volatility increases,  the value of the standard deviation also increases, and this is visible in Bollinger Bands as a contraction of the bands. Similarly, when the volatility decreases, also the standard deviation decreases, which is reflected in the Bollinger Bands as a contraction in which the upper and lower bands are closer.

Common uses of Bollinger Bands in trading

Now we will explain two of the most common ways to use Bollinger Bands: The Bollinger Bounce and Bollinger Squeeze.

The Bollinger Bounce

Bollinger Bounce, as the name suggests is the rebound in Bollinger bands.
The price usually tends to return to the middle zone of the Bollinger bands, much more in periods when the market moves sideways or in ranges. This idea can be useful in our trading to determine high and low points as well as entry and exit levels in the market.
The reason this rebound happens is because Bollinger bands act as minor supports and resistances. In price charts with higher time frame  (H4, D1) the resistances and supports represented by the upper and lower Bollinger bands respectively, will be stronger than in charts with shorter period. Remember that in strong market trends the Bollinger bounce will not work.
Following the Bollinger Bounce we can have two situations:
  • the price rebound in the upper band towards the middle zone 
  • the price bounce in the lower band towards the middle zone.
Image 2: Example of Bollinger bounces

The Bollinger Squeeze

We have seen the Bollinger Bounce that works very well in markets with lateral movement, but how the Bollinger bands will perform in markets with strong trends?

As we said, the Bollinger bands provide a lot of information on market volatility and the trend. An effective way to combine both data is through the phenomenon Bollinger Squeeze.

In markets with strong trend movements a good entry occur after a period of calm, a period that will be indicated by a contraction of the Bollinger bands since during that period the volatility decrease.
When there is a period where the market has low volatility and little movement, the Bollinger bands will shrink forming a narrow, almost horizontal channel. In this situation it is expected that a breakout to one side or another takes place sooner or later. If the price breaks the level marked by the lower band is expected to continue is bearish movement. Similarly, if, after the formation of this narrow channel bounded by Bollinger bands, the price exceeds the level set by the upper band, it is expected that the price continue to rise. Here is an example of breakout of a lower band.

Image 3: Example of Bollinger squeeze