WHAT ARE BOLLINGER BANDS?

What are Bollinger Bands? Let’s explore more about this index through COINSTRATEGISTS detailed article. We will help you see more clearly about this topic and important related information.

WHAT ARE BOLLINGER BANDS?

Bollinger bands are an indicator in technical analysis used to measure the volatility or signal overbought or oversold of the market. Bollinger bands were created by John Bollinger in the early 1980s. It is widely used by analysts. Based on it, we can tell whether the market is calming down or fluctuating.

Bollinger bands are applied on a price chart and they represent the standard deviation of a price level from its moving average (MA). The distance between the MA line and its Bollinger bands is determined by the level of price movement: The faster the price changes, the farther these bands will be from the moving average.

FACTORS THAT MAKE UP THE BOLLINGER BAND

What are Bollinger Bands? There are 3 factors that make up the Bollinger Band, including: Middle Band, Upper Band, Lower Band.

MIDDLE BAND

The middle band of the indicator is the simple moving average (SMA). Most current software or charts show a default of 20 stages. This is also the advice of experienced analysts to use the 20-period MA.

However, after mastering the use of Bollinger bands, you can switch to MA at different stages. It is not recommended to use a low-period MA. Because the number of stages in the calculation process is small, it will create a large level of volatility. As a result, the data becomes much less accurate.

UPPER AND LOWER BANDS

The upper and lower bands in order represent the two standard deviations above and below the moving average. And standard deviation is defined as a quantity used to represent the dispersion of prices around their mean: 

• Standard deviation: Covers about 68% of the price movements that occur. 
• Two standard deviations: Covers up to 95% of the values of the price level that appears. This means that if the index is based on the calculation of 2 standard deviations, then 95% of the prices will fluctuate within its ranges.

BOLLINGER BAND CALCULATION FORMULA

Bollinger Bands use 2 parameters: stage (cycle) and standard deviation. The values ​​to shape the standard formula are: stage is 20 and standard deviation is 2.

From there the following calculation is obtained:

• Middle band: SMA 20-day simple moving average.
• Upper band: SMA + 2 x standard deviation.
• Lower band: SMA – 2 x standard deviation.

For example: The calculation method is still the same as above but applies to short-term, medium-term and long-term analysis forms. The parameters can be set as follows:

• Short term: Use 10-day SMA, standard deviation 1.5.
• Medium term: Use 20-day SMA, 2 standard deviation.
• Long term: Use 50-day SMA, 2.5 standard deviation.

HOW BOLLINGER BANDS WORK

When the price of a one-time sideway increases, it increases the possibility that the price will rise sharply in either direction. This could start a moving trend. Be wary of a new boom phase.

Price tends to bounce in the heart of two bands. It taps on one strip then on another. You can use these changes to help determine the take profit level. Simply put, if the price bounces off the lower band and then crosses the SMA, then the upper band will become a take profit target if the price is near. 

Price can exceed or hug a band for long periods of time during strong trends. Regarding divergences with a momentum oscillator, you may want to do research on whether to take profits or wait for more to increase profits. 

For example:

The price moves out of the bands, continuing the strong trend. However, if the price immediately moves back inside the Bollinger Band, then the aforementioned trend will be eliminated. Summarize the above issues when it comes to each case. The upper and lower bands act as resistance and support, respectively. 

However, let’s not use the concept of resistance support to trade. Just like other indicators, you should combine them with RSI, MACD,… let the Bollinger band come into full effect.

– What is the RSI indicator?

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USING BOLLINGER BANDS AND KELTNER CHANNELS

Keltner Channels, introduced by Chester Keltner in his book in 1960 and later developed by Linda Raschke in the 1980s, are a volatility indicator different from Bollinger Bands. Instead of using SMA and standard deviation like Bollinger Bands, this indicator uses EMA and ATR to measure channel width.

Keltner helps identify overbought and oversold levels relative to the moving average. Especially when the trend is constant. Keltner Channels is capable of judging trend reversal points more consistently than the Bollinger bands.

The formula for the Keltner Channel also applies to 3 bands only. Common settings include the 20-day EMA and the 10-day ATR. 

• Upper Band: EMA(20) + 2 x ATR(10). 
• Middle Band: 20-day EMA exponential moving average. 
• Lower band: EMA(20) + 2 x ATR(10). 

Bollinger Bands are still more popular when compared to Keltner Channels, but they also offer many benefits over their competitors. However, when used in combination, there is nothing better than that. This not only provides good signals but also improves many other aspects.

CONCLUSION

What are Bollinger Bands? This is an indicator that is not too complicated but enough for new investors to approach the market. First, master these basics and then apply them in practice. This way, you can effectively optimize profits and minimize risks.