The worst enemy of a trader would be entering and then exiting trades at the wrong times—it is actually the biggest killer of either an opportunity or huge losses. Misconception of market volatility is perhaps one of the biggest mistakes since it ends up entering at the wrong time because of being too early or too late, hence caught in choppy, unpredictable market conditions.
Bollinger Bands is one of the most commonly applied technical analytical tools to measure the volatility of a market and potential moves in prices. Unfortunately, few know how to use them effectively because they lack a proper understanding of how to interpret the signals correctly, especially during shifts in volatility cycles.
If a trader knows how to use the best trading strategy using Bollinger Bands, they will be able to identify high and low volatility cycles and use those to their advantage while getting substantial moves in the market. This article will outline the key concepts behind the Bollinger Bands strategy and how it could be applied for the maximization of profit with minimal risk.
What Are Bollinger Bands?
Bollinger Bands are a technical charting tool developed by John Bollinger in the early 1980s. The lines that comprise them are three in number:
- Middle Band (SMA – Simple Moving Average): They are usually 20-period simple moving averages acting as average prices over some period.
- Upper Band: This is found by adding two standard deviations to the middle band, thus helping set the upper limit for price action.
- Lower Band: It is calculated by subtracting two standard deviations from the middle band. It indicates the lower price boundary.
These bands adapt dynamically with the market’s volatility. The more volatile the market, the higher will be the bands and vice versa. The reason this makes Bollinger Bands a great tool to spot trading opportunities according to the market conditions.
Trading Concepts in Bollinger Bands
1. Volatility Cycles
One of the core principles that guide the best Bollinger Bands trading strategy is understanding market volatility. Volatility indeed is defined by the price range whereby it is shown in the market. It helps identify high and low volatility periods that create various opportunities for trading.
- Low Volatility: This generally occurs when the bands are close together or narrow. Such instances signify periods of low volatility. Generally, in such times, the market is consolidating or moving within a range.
- High Volatility: Wider bands generally signify higher volatility and also tremendous price movements. This eventually ends up producing trends in the markets.
2. Timing is Everything: Getting in Early
One good strategy for profitable trading in Bollinger Bands is to get in before a high volatility cycle has begun. Many traders wait for the bands to already be wide before entering the trade, but by that time, the market often has already moved quite a distance, and you may be getting in too late.
Instead, look for times when the bands are tightening, indicating a flip from low to high volatility. At this point, you will be able to enter a trade and have a good-sized potential price move when the volatility does get underway. You are getting in ahead of the market so you can capture the move before it makes its largest swings.
3. Avoid Trading After High Volatility Moves
The second major problem people make in trading is scanning for highly volatile markets, looking for a big move to happen. It again intuitively seems like a good strategy to trade when volatility is high, but the problem is that by the time your scan identifies high volatility, the market has already made its move, and you are entering when the market is about to enter a low volatility cycle.
Just like trends, volatility acts in cycles. After you get in following a high period of volatility, the market may soon slow down and catch you in a choppy phase. That is why you should pay attention to the timing of your trades: you would want to try getting in at a time when the market transitions into a high-volatility mode rather than after it has started.
4. Volatility Does Not Indicate Direction
Volatility, per se, or by the measure of Bollinger Bands, is not a directional indicator. One of the biggest mistakes people make with Bollinger Bands is that they believe that a higher band automatically flashes an uptrend while a low band telegraphs a downtrend. Volatility and direction are two different things.
For example, you can see a market with very wide Bollinger Bands – that is telling you volatility is high. But the market still could be going in either direction, so it’s a very non-directional chop. And this is where so many people get confused and lose track of it. To get the best results from Bollinger Bands, you’ll want to go ahead and back up the bands’ signals with some other type of indicator or even a trend-following strategy to confirm what way the market’s going.
5. Using Trend Indicators with Bollinger Bands
Bollinger Bands are great at measuring volatility but most effective when used with other tools that can assist in the identification of market direction. Trend indicators such as moving averages or the Relative Strength Index (RSI) can limit false signals by confirming that the trend is indeed the given direction.
For example, when volatility is low, wait for some indication of trends as the breakout happens in the market. The coming together of these tools ensures that the proper trading direction will prevail in times of high volatility and maximize profitable outcomes.
The Best Bollinger Bands Trading Strategy: Step-by-Step Guide
1. Identify the Current Volatility Cycle
Use the following as a guide in analyzing the width of the Bollinger Bands:
- Narrow bands: anticipate low volatility cycle.
- Wide bands: anticipate high volatility cycle.
At this point, you will be aware of what kind of environment is prevailing.
2. Lock Down Opportunities for Early Entry
Once again, as discussed previously, in terms of timing, it is best to enter when the cycle has yet to start. As the bands tighten, you’ll be looking for any signs that are likely to lead to a breakout. Other confirmatory indicators like RSI can also be put to use as well for confirming potential direction in prices.
3. Waiting for Confirmation of the Trend
In this situation, the breakout must be validated by other trend indicators. It should be a buy trade on breakout above the upper band if the price breaks and is found to be upward with bullish momentum in the RSI. It is a positive indication of an uptrend and can generate a very effective trading opportunity.
4. Strategy of Using Stop Loss and Take Profit
As volatility sometimes causes wild and erratic movements in the market, managing your risk is important. Place a stop-loss order to close the trade in case of an adverse movement in the market. A take-profit target, based on the expected movement of the market, can also be set.
5. Exit Before the Market Loses Momentum
And finally, exit before the volatility subsides and the market registers a low volatility cycle again. The timing of exit is as important as that of entry. Manage to get in early and get out when the market loses steam to garner the utmost profit.
Conclusion
The Best Bollinger Bands trading strategy is all about knowing and timing market volatility cycles. An entry must be done before a cycle of high volatility to avoid entering trades when that cycle is already in motion, and other trend-following indicators should be used together with Bollinger Bands to make the trading result better.
It is a friend only if you know when and how to use it for the best. Bollinger Bands will help you anticipate a wide move, taking in potential market confusion and working it into profitable trades when there is the right timing and strategy attached. These techniques will be well on the way to making you become an effective and proficient trader.
