Trading Fundamentals Part 13: Bollinger Bands Explained

Using Bollinger Bands for Trading

There are several ways traders use Bollinger Bands:

1. Identifying Trends

The direction of the middle band, which is the SMA, shows the trend. If it’s rising, we may be in an uptrend. If it’s falling, a downtrend could be forming. The width of the bands gives clues about how strong or weak that trend is.

2. Spotting Overbought and Oversold Zones

When the price touches the upper band, it may be overbought. This could be a signal to take profits or go short. If it hits the lower band, it may be oversold, pointing to a potential buying opportunity.

3. Trading the “Bounce”

This strategy assumes that price tends to return to the mean. If the price bounces off one band, traders may aim for the opposite band. This works well in sideways markets.

4. Watching for Breakouts

A breakout outside the bands, especially with high volume, could mean a new trend is starting. But be cautious. Not all breakouts hold. Use other indicators to confirm the move.

Bollinger Bands Cheat Sheet

Action	What It Means	Common Reaction
Rising middle band	Possible uptrend	Look to buy or hold
Falling middle band	Possible downtrend	Look to sell or short
Bands narrowing	Low volatility	Prepare for breakout
Price above upper band	Overbought	Take profit or short
Price below lower band	Oversold	Buy or watch for bounce
Bounce from lower band	Price may target upper band	Set exit target
Bounce from upper band	Price may fall to lower band	Plan for downside
Price hugging upper band	Strong trend	Consider trend-following
Price drops outside lower band	Breakdown risk	Short or reduce exposure

Upper Band Signals

When price reaches or moves above the upper band:

• It can signal overbought conditions
• It may show expanding volatility
• It could be a breakout beginning

But don’t jump to conclusions. Sometimes, price hugs the upper band for a long time in a strong trend. That doesn’t always mean a reversal is coming. Check volume or use RSI to confirm.

In sideways markets, traders often sell when price hits the upper band and rebuy near the middle or lower band.

Lower Band Signals

The lower band shows oversold potential:

• When price touches or dips below it, a bounce could be coming
• It may indicate panic selling or bearish strength
• Long dips below the lower band may show trend continuation

This band is often used as a buy zone in ranging markets. If price keeps falling and breaks through with volume, a downtrend may be forming. Confirm this with volume or momentum indicators.

What Tightening and Widening Bands Mean

Tightening Bands (Squeeze)

When the bands are close together:

• Volatility is low
• A big move could be coming
• There’s often no clear trend

Many traders wait for the breakout direction after a squeeze before entering trades.

Widening Bands

Wider bands suggest high volatility. This can mean:

• The market is reacting to news or events
• A new trend may be forming

It’s a double-edged sword. With more volatility comes more risk. Traders should adjust their position sizes or stop-loss levels.

How Reliable Are Bollinger Bands?

Their reliability depends on:

• The asset’s typical volatility
• The chosen settings (SMA period and standard deviations)
• Confirmation from other tools

For instance, using RSI or MACD can filter out bad trades. Volume also adds important context. If a breakout happens with high volume, it’s more likely to stick.

Bollinger Bands work best when used in combination with other analysis methods. Alone, they may give false signals, especially in very choppy markets.

Alternatives to Bollinger Bands

Some traders prefer or combine other tools:

• Keltner Channels
• Donchian Channels
• Moving Average Envelopes
• Average True Range (ATR)

These indicators offer similar insights but use different math or approaches.

Common Limitations

1. Bollinger Bands are lagging. They reflect past prices, not future moves.
2. In volatile markets, they can expand too much and give unclear signals.
3. The default settings may not suit every asset or timeframe.
4. They don’t show direction on their own. Use confirmation.

Avoiding False Signals

To reduce false alerts:

• Pair Bollinger Bands with RSI or MACD
• Use volume as confirmation
• Avoid trading during unclear squeezes
• Adjust the settings to suit your asset

Using a 25-period SMA or increasing the deviation to 2.5 can help reduce noise in volatile assets.

Final Thoughts

Bollinger Bands are a flexible and widely used tool in technical analysis. They adjust to volatility and give insight into price trends and potential reversal points. While simple to read, they offer deep insights when used with other indicators.

If you’re serious about improving your trading, this tool belongs in your toolkit. But remember: No single indicator works all the time. Combine Bollinger Bands with sound risk management and other signals to build your edge.

Let the bands guide you, but always trade with a plan.

Note: This article is for educational purposes and does not constitute financial advice.