How to Trade Using Bollinger Bands

Bollinger bands are designed to give traders a feel for what the volatility is in the market and how high or low prices are relative to the recent past. The basic premise of Bollinger bands is that price should normally fall within two standard deviations (represented by the upper and lower band) of the mean which is the center line moving average. As this is the case trend reversals often occur near the upper and lower bands. As the center line is a moving average which represents the trend in the market, it will also frequently act as support or resistance.

The first way that traders use the indicator is to identify potential overbought and oversold places in the market. Although some traders will take a close outside the upper or lower bands as buy and sell signals, John Bollinger who developed the indicator recommends that this method should only be traded with the confirmation of other indicators. Outside of the fact that most traders would recommend confirming signals with more than one method, with Bollinger bands prices which stay outside or remain close to the upper or lower band can indicate a strong trend, a situation that you do not want to be trading reversals in. For this reason selling at the upper band and buying at the lower is a technique that is best served in range bound markets.

Buying and Selling at the Upper and Lower Bands

A Chart Showing the Strategy of Buying and Selling at the Bollinger Band Upper and Lower Bands

Large breakouts often occur after periods of low volatility when the bands contract. As this is the case traders will often position for a trend trade on a break of the upper or lower Bollinger band after a period of contraction or low volatility. Be careful when using this strategy as the first move is often a fake out.

Bollinger Band Contractions

As Bollinger bands paint a good picture directly on the price chart of how high or low price is relative to historical prices, this is a good indicator to use in conjunction with other methods such as some of the chart patterns that we have learned so far and some of the candlestick patterns which we will learn in future lessons.

Below is One Such Example

A Chart Showing Bollinger Bands with Multiple Confirmations