The Bollinger Bands indicator has been developed by now the famous John Bollinger and represents one of the most popular indicators traders use. The reason for this comes from the fact that it is visible, applied on price, and makes trends extremely easy to trade.
Being a trend indicator, the idea behind trading with the Bollinger Band indicator is to follow the trend and to find entries to ride the trend, namely to buy the dips in a bullish trend or sell the spikes in a bearish one.
The indicator is formed out of three elements: the upper Bollinger Band (UBB), the lower Bollinger Band (LBB) and the middle Bollinger Band (MBB).
While the UBB and LBB are fixed in the sense that they cannot be edited, the MBB is usually a simple moving average. However, it should be added here that a correct setup for the Bollinger Band Indicator will have an EMA (Exponential Moving Average) for the MBB, as it works better.
As you can see in the chart above, the three lines are created two different channels, and a bullish trend is defined when price is moving to the upside and stays in the upper side of the channel, while a bearish trend is defined when price is moving to the downside and stays in the lower side of the channel.
If price falls from the upper side of the channel but quickly bounces back, that was only an opportunity to go long, with the opposite being valid in a bearish trend.
There are two ways to trade with the Bollinger Bands indicator, namely to follow the trend and to buy dips or spikes or to use the indicator when trying to find a top or a bottom or a change in trend.
When looking to buy dips or sell spikes, the key comes from the MBB, or the Exponential Moving Average as it represents the first line of support/resistance and a great place to add to a position.
In a bullish trend, look for price to be rejected from the EMA and this means that minimum two green candles needs to form until a long trade should be taken. The take profit for the trade should be a new high and stop loss the value given by the LBB.
In a bearish trend, price needs to move higher into the EMA and two red candles are needed before going short with a take profit when market is making a new low and a stop loss at the UBB.
This way the trader is always riding the trend and while the take profit may seem a small one, the time frame should be considered as well. Imagine you’re trading the weekly or monthly chart and then the amount of pips to be made is growing considerably. After all, the trend is your friend so knowing when a trend is in place offers a lot of opportunities to find out profitable trades.
The other way to trade the Bollinger Bands indicator is to look for a trend reversal and it must be said before anything that this is a risky strategy. However, it is more rewarding because everyone wants to pick a top or a bottom so I would say it is well worth the risk.
It is being said that one should not try to pick tops and bottoms as most of the times this leads to losses, but using Bollinger Bands in this way may help.
The idea behind it is to look for a candle that touches both UBB and LBB as that is a reversal sign and shows the possibility of a new trend to start.
As you can see in the example above, the green candle touches both extremes of the Bollinger Band indicator and from that moment on a bullish trend starts.
To make the best use out of this indicator, one should use both strategies, trying to find out reversals and beginning of new trends and then riding the trend in the sense that new positions should be added using the examples in this article.
Bollinger Band indicator is a trend indicator so popular that it brought fame to its developer. However, it is not the most popular one, as Ichimoku Kinko Hyo and Moving Averages are favored by traders too.
Find out how to trade markets with them too in our next articles here on ForexGator.com.