Bollinger Bands are quite effective for technical analysis. These bands are plotted alongside a simple moving average and together, they indicate the volatility levels in the market. The Bollinger Bands strategy (also known as stratégie bande de Bollinger in France) is preferred by traders because it is not just effective but reliable. When it comes to using this strategy, there are several rules to follow. Some of the rules are very significant, especially for financial trading. Here they are.
1. They should be used for sporadic identification of viable points
Bollinger Bands are not like other technical indicators that might show continuous predictions of the market. Instead, they show spots on the overall trend that are great for investment.
2. They give a relative indication of highs and lows
The points identified as high or low by this strategy are relative and not absolute. In general, the lower band should indicate low price while the upper band indicates high price. From the indications, further derivations can be made.
3. Patterns are central to making derivations
Bollinger Bands sometimes trace troughs and crests on the chart. When the crests are prominent, it indicates the rise in volatility while the converse is true when the troughs are prominent.
4. The simple moving average is the quintessential formula for Bollinger Bands
It is common to see some other formulas being wrongly used with the strategy. The traditional formula for this strategy, however, is the simple moving average for the middle band. This is because the formula is applied to calculate the standard deviation. The standard deviation, on the other hand, is used in the outer bands.
5. The middle band should not be used as an indicator of crossover periods
A lot of traders assume that the middle band can show crossover price movements but this is not the case. The middle band is only accurate for showing short-term changes in the prices.
6. The space between the bands can indicate the status of the market
Generally, when the bands are wide apart, there is a great possibility of falling market volatility. This can be a great time to exit the trade. When the bands close into each other, the opposite is true.
7. Bollinger Bands can be used on market data for any duration
A key principle to note when using Bollinger Bands is that the duration of the bars is irrelevant. The strategy can work with hourly data, or even daily and weekly market data. The only necessary factor is that the market should be moving.
8. Bollinger Bands are versatile and applicable to any financial market
Even though the strategy is widely used in forex trading, it is also commonly used for the stock and options market among other areas. Bollinger Bands are consistent in predicting price action in any market that they are applied.
There are a couple of other rules to know when using this strategy. In total, you can find as much as twenty-two rules for using the bands. The above rules, however, capture the essence of the strategy. Following these rules will help you increase the success of your trading activities.