Bollinger Bands Indicator Explained

To a trader there is nothing more beautiful than to go with the move of a trend. Taking a position  when the trend has just started  and watching yourself getting richer with every pip the rate moves further in to the money will make every trader smile. This is exactly the same as range trading, only the trends are shorter in this.

Finding Trends With The Bollinger Bands Indicator

But when do speak of a trend? And how to find one? This is where technical analysis can help and where Bollinger Bands buying signals can play a role. Bollinger Bands preach a simple but fundamental thought that rates between 70% and 80% of the time are move in the same frequency. When they start moving outside this frequency that might be the start of a trend.

Bollinger Bands are measuring the standard deviation (SD) of the price, in comparison to the moving average over 20 periods.

When the Bollinger Bands squeeze this means a low volatility in the market, because the difference between the low SD and the high SD is small. When the Bollinger Bands width increases the price movement is very volatile, making it hard to determine what the market will do.

Bollinger bands

Open a position with Bollinger Bands indicator

Bollinger Bands are used to take or leave a position in an asset. To use the Bollinger Bands with success there are three important questions:

  1. Trend detection: when can we speak about a trend?
  2. Entry point: when to take a position?
  3. Exit point: when is the trend over?

Surprisingly the third one is the most important question. The value of exit points is much underestimated by traders. Most traders would like to know when to open a trade, but choosing a closing time is just as important. Many traders lose money on a trade for the following reasons:

  • They don’t know how to limit their losses.
  • They don’t know how to maximise their profits.

Both problems can be solved by determining the exit point.

Entry point – when to  open a position

Even when the candles are closing in the buy/sell zone, we don’t take position because we are looking for low risk probabilities. The difference in losing and winning trades has less to do with choosing a ‘winner’ and more with minimizing the risk and maximizing the profits before the chances have turned.

what is the bollinger bands indicator
The three brown lines in the image are representing the Bollinger Bands.

Price retracement are almost always there. Even in a gigantic bull market people are able to take profits and traders thinking of the bottom being in sight and take a position. Successful traders enter after a retracement. They don’t try to make trends but to follow a trend. If you get in just after a retracement you are significantly limiting the risk. If the price would even move away from the top or bottom there wasn’t a trend at all!

 

Exit point – when will the trend stop according the Bollinger Band signals?

Like stated this is the most important question to minimise the risk of trading and maximising the profit.

A lot of traders know this old-timers’ proverb: cut your losses short and let your profits run. This is seen as the Golden Rule in Trading. But if you know this proverb, how is it then possible you are suffering from losses more than profits? Answer: it is so difficult to stick to your own rules.

The biggest temptation in a casino or at a poker table is to bet more money when you are losing all of the stakes. Usually this leads to more losses, just like in trading the stock market where the traders thinks he read the charts well. To think about and determining the exit points can prevent this.

A trading Bollinger Bands Exit Strategy is for example the rate touching the opposite band. So in an uptrend touching the lower Bollinger Band means to get out. A trend movement which is not strong enough to stay above the opposite band is not worth taking the risk for. As a poker player would say: “know when to release a shitty hand”.

The exit point for taking a profit in Bollinger Bands can be the same as for accepting a loss, with the extra variation that you can also take a smaller profit when the rate hits the middle line. Maximising profit is not ideal now, but to some traders it is enough to take a little profit instead of losing it.

Using the Bollinger Bands in the correct way not only increases the chance of recognising a trend (and follow its success) also compels the trader to think about the exit points to accept loss or take profit. This makes you aware of the trades you make and clears the road to develop a winning trading strategy of your own.