Bollinger Bands are a technical trading tool created by John Bollinger in
the early 1980s. They arose from the need for adaptive trading bands and
the observation that volatility was dynamic, not static as was widely
believed at the time.|
The purpose of Bollinger Bands is to provide a relative definition of high
and low. By definition prices are high at the upper band and low at the
lower band. This definition can aid in rigorous pattern recognition and is
useful in comparing price action to the action of indicators to arrive at
systematic trading decisions.
Bollinger Bands consist of a set of three curves drawn in relation to
securities prices. The middle band is a measure of the intermediate-term
trend, usually a simple moving average, that serves as the base for the
upper band and lower band. The interval between the upper and lower bands
and the middle band is determined by volatility, typically the standard
deviation of the same data that were used for the average. The default
parameters, 20 periods and two standard deviations, may be adjusted to
suit your purposes.
What is Bollinger Bands?
Bollinger Bands are a technical analysis tool invented by John Bollinger
in the 1980s. Having evolved from the concept of trading bands, Bollinger
Bands can be used to measure the highness or lowness of the price relative
to previous trades.
Bollinger Bands consist of:
1. A middle band being a N-period simple moving average
2. An upper band at K times a N-period standard deviation above the middle
3. A lower band at K times a N-period standard deviation below the middle
Typical values for N and K are 20 and 2, respectively.
The bands cannot, as some have supposed, be used to make reliable
statements regarding what fraction of an equity's prices will lie within a
certain distance of the mean value. This is because an individual equity's
price does not obey known distribution functions (see stochastic process).
For example, if the bands for plus or minus two standard deviations (2SD)
are computed, it is wrong to suppose that ~95% of an equity's closing
prices will, on average, lie within the Bollinger bands. That would
require, among other things, that the prices be normally distributed,
which they are generally not. It would further require that the true
standard deviation be known. The standard deviation calculated as above,
however, is only an uncertain estimate of the true standard deviation.
Furthermore, it should be realized that the "standard deviations" of stock
prices for finite time periods are not fixed parameters as required to
apply classical statistical theory, but instead are variables in constant
flux depending on price volatility. The bands give a visual picture of a
stock's price volatility. Nevertheless, the bands can be useful in the
technical analysis of prices or returns and by Chebyshev's inequality
contain at least 75% of prices. These occurrences should be considered in
relation to other factors before making investment decisions.
It is of interest to note that faulty interpretation of a price touching
or breaching a band based on incorrect statistical assumptions has become
so widespread that some traders now use these events alone as trading
signals and by so doing may have unwittingly injected significance into
these band-touching events that should otherwise be absent. Nevertheless,
anyone can observe over time, that for a diversified group of mutual
funds, say, the proportion of daily adjusted close prices that breach
their 1-month 2SD Bollinger bands varies between 5% and 15% of days, with
each fund having a fairly constant, characteristic long-term breach
probability descriptive of its long-term, relative volatility.
When the bands lie close together a period of low volatility in stock
price is indicated. When they are far apart a period of high volatility in
price is indicated. When the bands have only a slight slope and lie
approximately parallel for an extended time the price of a stock will be
found to oscillate up and down between the bands as though in a channel.
The use of Bollinger Bands varies wildly among traders. Some traders buy
when price touches the lower Bollinger Band and exit when price touches
the moving average in the center of the bands. Other traders buy when
price breaks above the upper Bollinger Band or sell when price falls below
the lower Bollinger Band. Moreover, the use of Bollinger Bands is not
confined to stock traders; options traders, most notably implied
volatility traders, often sell options when Bollinger Bands are
historically far apart or buy options when the Bollinger Bands are
historically close together, in both instances, expecting volatility to
revert back towards the average historical volatility level for the stock.
HOW I USE IT
I use 2 Bollinger Bands with the same value on my technical charts. These
2 BB are for:
1. Trend Reversal Detection
2. Exit Target
3. Entry Point
Before we go on any further, a visual display is needed since we human
learn faster through our visual.
Click to Enlarge in new Window
As you can see in the graph, there are 2 BB with RSI. There are 5 set
of circle indicating when the price cut thru Bollinger Bands. I will try
to explain here according to numbers in the chart.
1. Price cut the upper BB at the same time RSI only cut thru middle band.
Indicating the price is over bought while RSI is showing weakness. That is
your point to short.
2. Price cut thru the lower BB and RSI is doing exactly the same. This
showing that the price is according to strength. Exit at will. This also
indicates a new trend has started. Take only short position from now on.
3. Same as no.2, this is your exit position. RSI agrees with the price.
Continue to trade short.
4. Price cut thru the lower Bands but RSI is in the upper part of the
Bands. This is a sign to start thinking of reversal. Lowest price at that
point was 1.0550. Normally I would give out signals based on that lowest
5. Price makes a new low of 1.0530 and RSI still disagree with it. This is
due to last minute trend traders who are pushing the price even lower
thinking the trend is still there. I must agree, the trend is still there
but the strength is gone long ago.
If I were to trade this pair, I would give out a signal to long @ 1.0550.
The price hit bottom at 1.0530. Meaning there was a -20 pip position hold.
Now the position is +30 and guess what. Its breaking the middle bands.
Once the middle bands is broken and it cut thru upper bands and RSI agrees
with it, we have ourself an uptrend. Meaning that I have trade the pair
much earlier than most traders do because they are trading on trend.
At the time of writing I am holding ucad long with SL at breakeven. The
worse thing that could happen is ucad reverse making a new low leaving me
with nothing. If all goes well, I would like to see that upper band and
make my exit there.
Of course there is no certainty in forex. In this article I am only
showing the possibilities of using only BB and RSI to trade forex.
Currently I am using 4 indicators to my technical analysis. Maybe some of
you out there can do much better and come up with a better system.
Click to Enlarge in new Window
As you can see in the picture, those circle are my entry and exit
point. At the time of writing, I have already closed 2 position with +97
pip and holding 1 position with SL at +8 pip. Thats brings a confirmed
total of +105 pip for ucad alone.
Looking at the chart, Ucad is still a long trade but there is not much
follow thru. This maybe to the fundamental effect saying usd dollar has
been so weak all this while making trader unwilling to enter on usd side.