Bollinger Bands are a popular and useful tool, but they can confuse you as a trader if applied incorrectly. Read on to learn everything you need to know about how to use this strategy to your trading advantage!
A Sword That Cuts Both Ways
Have you ever heard the saying about a sword that cuts both ways? It can be applied to a lot of different things, but it is basically applied to anything that is intended to do one thing while risking the opposite effect.
When it comes to Bollinger Bands, I think it appropriate to caution traders to take it slow; don’t get too far ahead of yourselves, but focus on one use of the tool at a time, get accustomed to it, and relax. The problem with Bollinger Bands is that there are a wide range of uses and trading techniques it can be applied to, and that range makes it very easy to get mixed and/or conflicting signals. This is a quick look at three (3) basic applications of Bollinger Bands trading techniques useful for short term traders using digital options on the IQ Option platform.
Digital Options are a ladder style option with expiry every 5 minutes. Traders can choose in the money, at the money, or out of the money strikes to suit risk preferences.
Support and Resistance
Bollinger Bands are great tools for finding and confirming support and resistance. The best thing about them is that they provide a dynamic support and resistance, once that changes as the market changes. When the market is calm, the lines move closer together because prices are hovering near a point of equilibrium between buyers and sellers. When the market is active, the lines move farther apart because prices are volatile and support/resistance zones are shifting. Volatility is an undeniable part of trading, so it’s important to know how to read it.
Regardless of their width, bollinger bands can be used as targets for entries and exits. Like most tools, these indications are best when used in some type of trend-following manner. If prices are trending higher, touches to the lower boundary and to the mid line can be used as trend following support entries. Meanwhile, if they are trending lower, touches to the upper boundary and the mid line can be used as trend following resistance entries.
Multiple Time Frame Analysis
Multiple time frame analysis is the power behind the Stochastic Power Play technique I described a few weeks ago. It uses a longer time frame to determine trend and a shorter time frame to get signals. Bollinger Bands work well in any time frame and are well suited to this type of analysis. Use a Bollinger Band on a daily chart to get entries on an hourly chart, or use and hourly chart to get signals on a 10, 5, or 1 minute chart. If, on the longer time frame chart, the price is bouncing up from the lower signal line, or up from the mid line, then look for bullish entries on the lower time frame. If, on the longer time frame, the price is moving down from the upper signal line, or down from the mid line, then look for bearish entries on the shorter term chart. Digital Options traders may want to use a 30 minute or 1 one hour chart for trend and major support resistance then move down to 5 minute or 1 minute charts for signals.
Signal Line Breaks
Bollinger Bands are best thought of as trading ranges — dynamic highly elastic trading ranges — that give signals in the same manner. When prices are ranging or range bound, they will move up from support and down from resistance as in the first technique I described in this post. If, however, prices break through a signal line they can give a much stronger signal. The caveat is that it must be a firm break of the signal line because you don’t want to confuse it with a test of resistance.
A break of the line, either the top or bottom or the mid line, is an indication of changing market sentiment and constitutes a break out. Prices can be expected to continue on in the direction of the break out, or if they fall back from that point to retest the point of break for support/resistance. The mid line does count in this technique as it will often provide support/resistance as well. A break to the upside is bullish, especially if found within an up trending market, a break to the downside is bearish and strong when found in a down trending market. This one hour chart shows a number of bullish, trend following line breaks that all result in at least one more candle of further upside.
Have you traded with Bollinger Bands? If not, try starting out with one of the techniques mentioned above. Use your demo account to get a feel for it, and apply it to your next trade when you’re ready. As always, we wish you a pleasant trading experience!Trade now
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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