8 min read
Bollinger Bands are an indicator of technical analysis that allows to effectively predict the future behavior of the price chart.
What are Bollinger Bands?
Bollinger Bands are composed of a moving average and two bands associated with it. The latter represent a standard deviation from the moving average. In short, the higher the price volatility, the greater the distance between the bands and the moving average.
The trading bands are at a standard deviation (SD) compared to the moving average
In other words, the higher the standard deviation, the greater the range of the underlying price will be for a given period of time. Measuring the price deviation from its average values is very useful for predicting future price movements.
How does it work?
As mentioned previously, the indicator consists of three lines: an exponential moving average (EMA) and two price channels, one above and one below it. Price channels are magnified when volatility is high and contract during the flat market.
For investors, volatility is just as important as price direction and the strength of the trend. The volatile markets provide additional trading opportunities.
If you want to use Bollinger Bands in trading, it is important to understand that they are based on a simple concept: when price levels rise / fall excessively, they are likely to show a rebound later on. Periods of reduced volatility are generally followed by significant market movements, which may also be predicted thanks to Bollinger Bands. All these elements can be exploited by traders to determine the optimal entry points.
How to set it up?
Setting up the Bollinger Bands on the IQ Option platform is very simple.
1. Click the "Indicators" button in the lower left corner of the screen and select "Bollinger Bands" from the list of available indicators.
Indicator setting: first step
2. Then click on "Apply" if you prefer to work with the recommended settings. Otherwise, go to the "Set and apply" tab and you will have the option to adjust the period and standard deviation.
Indicator setting: second step
3. The indicator is ready to be used!
How to use it in trading?
In order to effectively use Bollinger Bands in daily trading, it is essential to understand the basic characteristics of price volatility and its applications in trading.
Normally, periods of low volatility are generally alternated with periods of high volatility. During a downward trend, the price usually fluctuates between the lower band and the middle line. In the upward trend, on the contrary, the price lies in the corridor between the upper band and the middle line.
Periods of low and high volatility identified by the Bollinger Bands indicator
The longer the market remains calm, the higher the chances of an imminent increase in volatility. Bollinger Bands are ideal for identifying these moments. Using this indicator, the trader is able to predict future volatility fluctuations and determine overbought / oversold positions, opening operations at the most appropriate time. However, it is also important to remember that no indicator is 100% accurate. All indicators can provide false signals.
When the asset leaves the "normal" price range, most risk-averse traders stop opening new deals and wait for the market to stabilize again.
The situation in which the price ranges are approaching is called squeeze, or crushing. These periods indicate a low current volatility and a potential high volatility in the near future. However, the indicator does not provide the trader with information about a particular moment in time when volatility is supposed to increase. Traders remain mostly inactive during crushing.
About 90% of the price action occurs between the price bands. The event that happens in the remaining 10% of cases is called breakout, or breakup. A breakout occurs when the price action abandons the "normal" price range. It should not be used as a trading signal, as it does not provide any information on the strength and future direction of the trend.
Combine and conquer
Bollinger Bands are able to show current volatility and sometimes predict future market fluctuations, but this is not a universal trading instrument. According to Bollinger himself, this indicator should be combined with other indicators, for maximum predictive potential and maximum effectiveness.
Bollinger Bands are an indicator that is worth knowing and using in real-life trading. Not only is it useful, but it can also promptly provide for signals of purchase or sale.
This article does not represent an investment advice. Any reference to past movements or price levels is informative and based on external analyzes, we do not provide any guarantee that such movements or levels may reoccur in the future. In accordance with the requirements set by the European Securities and Markets Authority (ESMA), trading with binary and digital options is only available to customers categorized as professional clients.
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Source: IQOption blog 2018-10-25 12:00:22