Presentation of Bollinger Bands:
The Bollinger Bands are a type of indicator created by John Bollinger that is used to analyse the volatility level of an asset price. To do this, the Bollinger Bands are used to compare this volatility to the asset price over a defined period.
The Bollinger Bands are actually displayed in the form of three distinct bands:
- The upper band represents the simple moving average plus X times the typical difference.
- The middle band shows the simple moving average.
- The lower band corresponds to the simple moving average less X times the typical difference.
In a general manner, the asset price is expected to move inside the middle band, between the upper and lower band. We can therefore say that the Bollinger Bands adjust according to the market volatility.
In fact, when this volatility is weak, the typical difference is also small and the Bollinger Bands are therefore closer together. On the contrary, when volatility is high, these bands become further apart.
How to use the Bollinger bands when trading?
We have already stated that the Bollinger Bands are primarily useful for estimating the volatility level of an asset price during a given period. But they are also useful for detecting other useful information such as the following:
- The strength of the trend: This can be observed by the crossing of the Bollinger Bands by the asset price. When the price crosses the upper band this indicates a strong rising trend. On the contrary, when it crosses the lower band we observe a strong falling trend.
- The support and resistance levels: When the market does not show a particularly strong trend, the Bollinger Bands can be used to indicate the levels of support and resistance as the asset price tends to oscillate between the upper and lower bands.
- A fall in the volatility: If the upper and lower bands become closer to each other this represents a fall in the volatility level of the asset price. We already know that these periods of low volatility often precede a sharp price rise.
- The direction of the trend: Charts showing double dips or double peaks enable you to anticipate a reversal of the trend. To summarise, when a double dip forms near the upper band with a dip in this band and another just below, this indicates a falling signal. When, on the contrary, two successive peaks appear, the first near the lower band and the other just above it, this represents a good rising signal.
The use of this indicator that displays and compares the differences between the two Bollinger Bands (upper and lower) is also interesting. When the latter tends to rise this indicates that the difference between these two bands is increasing when compared to the single moving average.
This means that the asset price is entering a distinct trend and it is therefore the right time to take position. When the difference between the two bands decreases this therefore indicates that the trend is weak and the volatility lower.