The Bollinger Bands indicator has a strong relationship with volatility and can help us anticipate strong movements and identify buy and sell points.
To add it, simply click on Indicators and select Bollinger Bands.
By observing the chart of an asset over time, it is possible to identify periods of high volatility and others where there seems to be a certain calm between buyers and sellers. However, a detailed analysis of the chart reveals more. The price of an asset rarely strays far from a specific region, as it is constantly drawn toward an equilibrium zone. This zone can be identified using moving averages.
Based on these observations, technical analyst John Bollinger created Bollinger Bands. They consist of two lines, an upper and a lower one, drawn at a specific distance from a moving average.
This concept is essentially the same as that of envelopes. In envelopes, we also have two lines calculated based on a certain percentage distance from the average. The difference introduced by Bollinger lies in the use of standard deviation. Let’s briefly review some statistical concepts.
A Bit of Statistics
A single measure of central tendency is not always sufficient to satisfactorily describe a dataset. It is not enough to know the value around which the data is concentrated. It is also necessary to understand the degree of aggregation, meaning defining and using mechanisms to quantify the level of data dispersion. Standard deviation is precisely a measure of the dispersion of a dataset relative to its mean.
Applying this concept in the context of technical analysis of an asset, the standard deviation becomes a measure of volatility. In other words, the higher the volatility of an asset, the greater its standard deviation. The bands are therefore plotted at a specific number of standard deviations from the average.
Most of the time, prices will remain confined within these limits. As can be observed, there is a direct relationship between Bollinger Bands and volatility. This integration is very interesting and can be easily visualized graphically during periods of accumulation and when price movements accelerate.
Interpretation Rules
There are several ways to observe and interpret Bollinger Bands. Let’s look at some of them:
Narrowing
Often, a decrease in an asset's volatility occurs due to a certain balance between supply and demand. This decrease has a direct impact on the bands, as they move closer together, creating a much narrower channel. This can be an indication that a strong movement is coming.
Observe the chart above of USATEC. On March 17, the bands narrowed, and after this period, an upward movement began. At the same time as the rally started, the bands began to widen again, reflecting the increase in volatility.
In this way, the bands provide us with an early signal that a trading opportunity may be approaching. We can try to determine which direction the market will move with the help of some indicators. One technique is to look for divergences or assess overbought and oversold conditions using an oscillator like the RSI, while also considering the information provided by volume-based indicators.
In these situations, these indicators play an important role, as volume evaluates the degree of financial commitment from investors. In the chart below, the red arrows indicate a downward price movement preceded by an upward movement, while the OBV (On-Balance Volume) develops a more pronounced upward trajectory (bullish divergence).
Touching the Bands
One of the fascinating aspects of technical analysis is that even under the same conditions, two analysts often interpret the scenario in completely different ways. Below, we will analyze two perspectives on using Bollinger Bands that may seem contradictory at first glance.
One of these rules states that when the price exceeds one of the bands, the expectation is for the movement to continue. This statement is entirely reasonable, as the price surpassing the band constitutes a manifestation of strength.
In this chart of USATEC from March 12, we see prices exceeding the bands several times during an upward movement. This is a good way to trade and take advantage of the trend, especially for those managing positions over some time.
On the other hand, shortly after reaching one of the bands, the market often reverses in the opposite direction, even if it’s just a brief pause before continuing the climb or decline. This happens because when prices reach the upper or lower band, they have already moved significantly away from their average and become vulnerable to corrections. From this perspective, exceeding a band is actually a warning that suggests closing positions.
The conclusion is that the strategy for using Bollinger Bands depends on the trading plan. Is the goal to hold the position for some time or to execute short-term trades? Will the trades be short or very short, such as day trades? Under what technical conditions will the exit occur? Where will the stops be placed? These questions must be answered when developing the plan.
Other Usage Tips
Among other uses, we can also highlight the fact that Bollinger Bands serve as good price targets. For example, a movement that starts at one band tends to travel all the way to the other band. Another interesting mechanism suggests that tops or bottoms made outside the bands, followed by tops or bottoms made inside the bands, are a good signal of a trend reversal.
For more information about this tool, you can refer to John Bollinger’s book, Bollinger on Bollinger Bands.
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