Bollinger Bands – A Starter Guide – Part 2

If you’ve read through Part – I of our Bollinger Band series, it’s time to look into some applications of Bollinger Bands and trading strategies you can build around them.

1. Following Trends using Bollinger Bands

Bollinger bands are used for measuring deviation, and therefore, this indicator can be very beneficial in recognizing a trend. We can generate two sets of Bollinger bands, one set with the help of “0.5 standard deviation” and the other using “3 standard deviations”.

In the chart of Tata Consultancy Services shown below, we can observe that whenever the price holds between the upper Bollinger Bands +0.5 SD and +3 SD away from the mean, the trend is in the upward direction, and therefore, this channel is known as the “buy zone.”

Contrarily, if the price is within the Bollinger Bands –0.5 SD and –3 SD, it is referred to as the “sell zone.” Finally, if the price moves between the +0.5 SD band and –0.5 SD band, then it is in a “neutral zone.”

Bollinger Bands keep on adapting to the expansions and contractions in price, because of the increase and decrease in volatility. Because of this, bands widen and narrow down in sync with price action, creating a highly accurate trending envelope.

Coming back to the chart again, the trader may take a long position when the price enters the “buy zone”. The trader’s target should be able to stay with the move for most of the uptrend and exit only when the price starts to consolidate at the top of the new range. An exit from this trade should be made when a red candle is formed and more than 75% of the candle’s body is below the “buy zone”.

2. Squeeze and Breakout Strategy using Bollinger Bands

This trading strategy is based on predicting price breakouts using volatility.

The volatility of the market is constantly changing from low to high and vice versa. This implies that if the market is in a low volatility phase, eventually, volatility will pick up in the future, leading to large price movements and breakouts.

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Bollinger Bands can be used both for intraday and swing trading, depending upon the time frame which the trader wants to use.

For using this strategy, we need to find conditions of low volatility or specific less volatile markets and predict when a breakout might happen and in which direction it will be.

For this purpose, we need to find a market that is moving in a range. We can quickly identify this by looking at the middle SMA line. The line needs to be relatively flat, as shown in the chart of Nazara Technologies Ltd., and the two bands must be close to each other.

This task can be made easier by using an indicator called the BBW or Bollinger Bands Width. You can easily get this on a trading platform. This tool shows the distance between the two bands.

If the BBW is low, it means the gap between the two lines is close, and if it is high, it means that the gap is set further apart. The two indicators need to have the same settings for them to work.

Further, to predict the price breakout, we need to wait for the standard deviation lines to start expanding, which can be easily identified by the rise of the BBW. This means that there’s an increase in volatility and a breakout is likely to occur.

The direction of the breakout depends upon whether the candle is breaking the upper line or the lower line. Accordingly, selling or buying of stocks is done.

In this chart of Nazara Technologies Limited, we are using a 15-min time frame. We can observe a flat SMA, meaning that the market is in a range and the two bands are contracting, which a low BBW confirms.

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After some time, the bands start to expand, which is also confirmed by the rise in BBW. Then, a red candle breaks out of the lower line, which is an excellent opportunity to take a sell position and make an entry. The lowest point of this same candle is taken as “Stop Loss.”

As shown in the figure, the exit should be made when the price breaks the middle SMA line.

Let’s look at another example.

In this chart, we are analyzing Wipro Limited with a time frame of 1 day.

We can observe that the market is in a range as shown by the flat SMA, and the gap between the two bands is close, which is also represented by a low BBW.

Next, we can see that the bands are starting to expand, confirmed by the rising BBW. Then, a green candle breaks out of the upper line, and this is an excellent opportunity to take a buy position and make an entry.

The lowest point of this same candle can be set as stop loss. As shown in the figure, the exit should be made when the price breaks the middle SMA line.

As you can see, Bollinger Bands can be one of the best trading indicators to use. On an Algo trading platform like PHI 1, you can use over 120 technical analysis indicators and customize them as per your trading strategy.

In fact, PHI 1 offers charting, screening, back testing and forward testing as well as strategy grading and deployment – all on a single automated trading platform.

You can explore Bollinger Bands and a lot more by availing a free trial!

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