Bollinger Bands Explained – Formula And Indicator Tutorial – BinaryOptions

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Bollinger Bands Explained – Formula And Indicator Tutorial

Bollinger Bands and binary options form a great combination that makes trading the financial markets simple, quick, and effective. Bollinger Bands provide a deep yet simple-to-understand look into the market’s soul; binary options are the ideal tool to trade the predictions that this look creates.

In this article, you will learn:

  • What Are Bollinger Bands?
  • Why Do Bollinger Bands Work?
  • Why Should Traders Use Bollinger Bands?

With this knowledge, you will immediately be able to trade binary options based on Bollinger Bands.

What Are Bollinger Bands?

Bollinger Bands are a technical indicator. They predict future market movements solely based on past market data, which they aggregate and calculate. The result is drawn directly into your price chart.

The indicator creates three lines, which are commonly referred to as “bands“:

  1. A middle line. This is the main line. It is a moving average, commonly based on 20 periods.
  2. An upper line. This line is the result of the moving average plus the standard deviation multiplied by a factor, commonly two.
  3. A lower line. This line is the result of the moving average minus the standard deviation multiplied by a factor, commonly two.

These three lines predict the range in which the market is likely to move.

  • The upper line is the upper end of the predicted range. It works as a strong resistance.
  • The lower line is the lower end of the predicted range. It works as a strong support.
  • The middle line is an additional barrier. It works as a resistance when the market is trading above it, and as a support when the market is trading below it.

In real-life trading, Bollinger lines predict three things:

  1. The market will remain inside the two outer lines.
  2. When the market approaches the middle line, it will slow down, but can eventually break through it. It can also turn around.
  3. When the market is moving between two lines, it will continue its movement until it reaches the next line.

All of these predictions are tradable, and binary options make trading them easier and more profitable than most other assets.

Why Do Bollinger Bands Work?

To understand the idea behind Bollinger bands, consider these examples:

  • If an apple was priced at £1 for a while and suddenly became more expensive, for example £1.20, fewer people would buy it. This drop in demand would bring the price back to £1.
  • If an apple was priced at £1 for a while and suddenly became cheap, many people would start buying apples instead of other fruit. This surge in demand would bring the price back to £1.

Now, these examples do not say that the price of an apple will never change. It can change – slowly and over time. Rapid price changes, however, are short-term fluctuations. Unless there is a catastrophic event, market psychology requires price changes to take some time.

Bollinger Bands reflect this assumption. The moving average that creates the middle line is the long term price change. The upper and the lower lines create the price channel in which the price can fluctuate.

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  • When the market approaches the upper band, you know that traders will soon think, “This asset is getting too expensive.” Demand will drop, and prices will fall back closer to the middle line.
  • When the market approaches the lower band, you know that traders will soon think, “This asset is really I should buy it.” Demand will surge, and prices will climb back closer to the middle line.

In short, this technical indicator helps you to understand market psychology without having to talk to every trader out there. This understanding helps you to make better investments with a quick, simple look at your price chart.

Why Should Traders Use These Bands?

Bollinger Bands can be a great help for binary options traders. They can do three things for them:

  1. Find new trading opportunities. When the market approaches a Bollinger band, you know that the market is likely to turn around. This knowledge alone is enough to win a binary option.
  2. Make more money with your strategy. Bollinger bands provide a clear indication for how far the market can move. Binary options types with high payouts such as ladder options or one touch options require this prediction, which is Bollinger Bands can turn an ordinary strategy into a highly profitable one.
  3. Help you avoid bad trades. Bollinger bands form important resistance and support levels. Even if you decide to not directly trade Bollinger Bands, you should at least be aware of these levels. Otherwise, you might be surprised when the market does something unexpected, and you lose a trade you believed to be a sure winner.

In addition to these three reasons, there is another aspect that makes Bollinger Bands so attractive – they are simple. All you have to do to interpret Bollinger Bands is take a quick look at your price chart. There is almost no chance to get it wrong, and you can finish the entire analysis in a few seconds. Traders who analyze many charts simultaneously love Bollinger Bands because they provide such clear predictions in such a simple way.

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Conclusion

Bollinger Bands are a great tool for binary options traders. At a glance, they provide a deep look into the thought process of all traders and the psychological processes that drive the market. This knowledge can help you find new trading opportunities, make better trades, and avoid bad trades. Any trader can profit from adding Bollinger Bands to their chart, even if they are only using them indirectly to better understand the market.

Traders can also base their entire trading strategies on Bollinger Bands. Our strategy pages include 3 Bollinger Band strategies

If you like binary options, Bollinger Bands will help you to trade better. If you like Bollinger Bands, binary options provide you with a great tool to trade their predictions.

Using Bollinger Bands in Binary Options

What is a Bollinger Band?

The Bollinger band indicator was developed in the 1980s by John Bollinger (BollingerBands.com). Three bands make up this Bollinger indicator:

a) The upper band which serves as a resistance band in range-bound markets.

b) The middle band which has a neutral bias in the sense that it can function as a resistance for price action coming from the lower band, or as a support for prices coming from the upper band.

c) The lower Bollinger band which serves as a support band, especially in range-bound markets.

Bollinger bands have a horizontal orientation at areas where the market is in consolidation. When the price movements are very minimal, they tend to contract into tight bands known as the squeeze. When the market experiences a breakout, they also break into wide bands.

In terms of trading binary options, the best way to use Bollinger bands in a manner that will not create an ambiguous situation for the trader is to use them in range bound markets to determine clear-cut areas where a price bounce (at the upper Bollinger) or price retreat (at the upper Bollinger) occur.

For this to happen, the trader has to apply the Bollinger band to a range bound market, and add an indicator that shows when the market is overbought or oversold (such as the Stochastics oscillator). With the help of the Stochastics oscillator, it is then easy to take a bullish position at the lower Bollinger when the market is oversold, or assume a bearish position when the market is overbought at the upper Bollinger band. You can read more about this in our 60s binary options strategy lesson.

Trading System using Bollinger Bands:

One system that can be used to trade this system is the Basic Bollinger system, which utilizes the Bollinger band, the Stochastics oscillator and the automatic pivot point calculator. Using this system which was initially developed for the forex market, the trader can trade as follows:

Call Option (read about the Call/Put Option here)

– Stochastics set at 10,3,3 is oversold ( 75)

– Price is at upper Bollinger band

– Price is close to a resistance level on pivot point

The expiry for the trade must be set using the time frame chart as a guide. For instance, when using a one hour chart for the trade analysis, it is expected that the asset should be able to perform according to expectation in about 3 hours. When using a daily chart, the asset should be able to perform in 2 to 5 days. Eventually, the exact expiry time to be used will depend on the experience the trader has garnered from using a demo platform.

There are other ways that the Bollinger band can be used. One of them is to use what is known as the Bollinger squeeze. The Bollinger squeeze is formed when price is so contracted that the length of the candles is thin, showing a breakout potential. The trader can then use price targets above and below the squeeze for a potential boundary trade. It is better to use the OUT option in this case, as the OUT option is a binary options outcome that does not have a bias (either a breach of the upper limit or lower limit will put the option in profit). Since it is not certain to which direction the asset will break out to, but it is certain that a breakout will occur, the trader can apply two trend lines above and below the squeeze. The most recent price highs and lows should be used as a guide, and the trend lines applied below the high and above the low. This will ensure that a breakout that aims for these key levels will trigger one of the two upper limits before anything else occurs.

These are the two surest ways to use Bollinger bands to trade binary options, and they must be used after some experience has been gained with them on demo.

More About Adam

Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

Bollinger Bands

One common feature is similar for any chart and any asset class in the financial markets – prices always move like waves. Binary options type of trading is keen on taking advantage of that attribute of quotes behaviour. Any strong trend comes together with healthy retracements from time to time with rates of underlying assets coming back to average values, while bullish or bearish accelerations are accompanied by higher volatility. Bollinger Bands binary options Strategy became popular thanks to the simple view and clear indication of those three basic factors for the price action – average value, volatility and fluctuations range.

What Is a Bollinger Band?

What do Bollinger bands show?

  • The middle line points to the average value of the underlying asset. This is a standard exponential moving average with the chosen period;
  • The upper line shows the current resistance. This is a dynamic curve, the value of which depends on recent price action and volatility. When quotes are placed between the middle and upper line, the binary options market is in the uptrend;
  • The lower line indicates the support level. It also changes the value if prices move fast. Downtrend conditions occur when rates are between the middle and lower lines.

The screenshot below shows the structure of Bollinger Bands explained:

Bollinger Bands settings

The indicator has two main parameters influencing the overall view:

  • The first one is the period or length, which affects the middle moving average. The larger period is set, the wider Bollinger Bands’ range is shown. The default period is 20 bars. Choosing the right period depends on individual binary options strategy, the preferred expiration time for binary options and the selection of an underlying asset. The most common Bollinger Bands Binary Options strategy suggests using period like 21 or 34 bars.
  • The second parameter is a deviation . Usually, binary options choose deviation 2, while a smaller value would squeeze the indicator’s vertical range, and a higher value spreads the amplitude. There is also a Double Bollinger Binary Options trading strategy, implementing two indicators with different deviations.

Here is where settings can be changed:

How to read Bollinger Bands?

Reading Bollinger Bands stock charts is simple as the indicator reflects the price action and change in the momentum.

There is a general set of rules describing several events in the binary options market:

  • During a strong uptrend or downtrend, Bollinger Bands lines spread the overall range between them, and head in different directions. That is a strong signal about larger volatility, and chances for a bullish or bearish acceleration grow, depending on the trend direction.
  • If Bollinger Bands lines narrow the overall range after a strong trend, then a retracement or correction is likely, and the price might bounce back to the average value, as the volatility drops.When a price crosses the middle line, that usually points to a change of the current sentiment.
  • If the crossover was charted from below to above, then the bearish bias would change to the bullish one.
  • If a daily (weekly, hourly) close price (not a shadow of the candlestick) appeared above the upper line or below the lower line, then a bullish or bearish breakthrough might happen, predicting higher or lower prices to be charted in the nearest future.
  • If a test of the resistance/support happened, and an asset charted a whipsaw above/below the line but failed to breach it with the close price, then a rebound to the middle line is likely.

Here is an example of bollinger bands stock chart in action:

How to use Bollinger Bands?

Like any other system based on the technical analysis, Bollinger Bands aims to find reversal conditions, calculate the average value, as well as determine resistance and support levels. Given the mathematical formula based on calculating channels, the indicator has the most effective performance during sideways consolidation ranges as it clearly shows the market’s intentions from the previous action. At the same time, the start of a strong trend is also visible when Bollinger Bands lines spread the overall range, pointing to larger volatility. Thus, binary options traders can take advantage of the Bollinger Bands indicator to maximise the profit when prices chart a one-way performance.

Therefore, before trading with Bollinger indicator, traders should make several preliminary conclusions:

  1. Find out whether the underlying asset is in an uptrend, downtrend or consolidation on larger timeframes than the chosen expiration time;
  2. Determine whether a reversal or by-trend trading strategy is preferable;
  3. Decide whether to buy call/put options is more attractive or the two-way strategy is desirable.

After, that traders can use the rules described above. For example, buy call options after the price crosses the middle line, targeting the upper band as the level when to stop the trading cycle. Or enter against the bullish trend, buying put options when rates failed to break through the upper line.

If you like this strategy, you might also be interested in this Trend line Trading Strategy

Examples of profitable trades

Intraday two-way trading on currency cross-rates in both directions

The screenshot below shows how effective the binary options strategy is when the underlying asset is in a sideways range, even though with a slightly bullish bias. Several entries were used on reversal signals, while the number of profitable deals clearly overweights corrective candlesticks during all of the three intraday trading cycles shown on the chart.

Combination with Bollinger Bands and ADX Indicator

Several additional technical tools might be added to the technical analysis in order to compensate Bollinger Bands weak points and filter false signals. One of the most effective tools for such a combination is the ADX indicator, which shows the markets momentum. If the ADX mainline edges higher, and the ADX surplus is negative (red), while prices reach the bottom range of the Bollinger Bands, then the likelihood of bearish continuation is high. However, if the rate failed to chart a bearish breakout, then it’s worth waiting for a retracement to the middle line before continuing buying call options. Here is the GBP/USD daily chart setup to use Bollinger Bands together with ADX indicator.

Pros and Cons

Despite the indicator’s informative view compared to standard moving average, and effective trading signals with simple rules and clear conditions, the Bollinger Bands binary options strategy, like any other lagging indicator might show false signals, especially when the binary options market is affected by large volatility and sharp price swings. That is mostly related to breakthrough signals, which do not guarantee further movements in the same direction.

  • Simple view;
  • Informative data representation;
  • Flexibility of settings;
  • Effective signals;
  • Indication of volatility.

Cons:

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