Whether you have been trading for a while or are a beginner, a detailed trading strategy can increase your chances of winning a huge payout. That’s because a trading strategy is like a blueprint to winning.
Fortunately, multiple strategies are available for trading binary options. But these many options can easily make you feel overwhelmed. You can, however, rely on a simple strategy, i.e., Bollinger Bands trading strategy, because it’s easy to use.
This strategy is excellent for beginners and pro traders. You can use it to get a better understanding of the market. But for that, you must know how to calculate Bollinger Bands. Also, it’s essential to know about the different parts of this theory.
This post contains all the relevant information.
What are Bollinger Bands?
Bollinger Bands is a crucial technical tool that traders use in the binary options market. John Bollinger created the theory, and it works by forming a channel around price movement. The formed channel in the chart is a result of standard deviation and moving price average.
With the help of Bollinger Bands, one can quickly make a winning prediction. This simple-to-use tool looks into the market’s soul and helps in understanding the market movement.
You can also see Bollinger Band as an indicator that predicts future market movement by analyzing the previous market data. This tool aggregates and calculates the past data and then draws a correct result on the price chart.
Ideally, short-term traders use this trading strategy as it indicates low market volatility. Not to mention, this tool gives a signal to the traders when the market starts moving. This way, traders can make a quick decision without missing any profitable opportunity.
Different parts of Bollinger Bands
The represented data on the chart is shown by three lines. These three lines are the band of this strategy.
An upper line
The upper line in the Bollinger Bands trading chart is essential. It results from moving averages plus standard deviation that is further multiplied by a factor, commonly two.
This line shows the upper end of the predicted price range. Also, it works as a strong resistance.
A lower line
This line represents the lower end of the predicted price range of an asset. It acts as strong support in the chart. It is formed as a result of standard deviation minus moving average. The sum is further multiplied by a factor.
A middle line
This line is also termed as the main line. It’s the moving average and is generally based on 20 periods. The interesting thing about the middle line is that it becomes resistance when the market is trading above. Similarly, it becomes support when the market is trading below.
Ideally, Bollinger Bands lines in real-life trading predict three things.
- If the market approaches the middle line, prices will slow down. However, it can break through or turn around.
- Similarly, if the market moves between two lines, the asset price will continue to travel in the same direction until it reaches the following line.
- Lastly, the market price will always stay inside the two outer lines.
So, you can conclude that Bollinger Bands help traders know the right time when they should enter and exit the market. The suggested time is when risk is limited, and profit is more.
How do Bollinger Bands work?
If you are still confused, here’s a quick example to help you understand the Bollinger Bands concept.
Imagine a situation where the price of a commodity is $20. In a few weeks, the price increased to $22. Now, in this situation, after a sudden price move, only a few people will show interest in that commodity. Thus, the price will come back to $20.
Similarly, if the price of the same commodity drops to $18. In this situation, more people will show an interest in the item. Thus, the market will be forced to bring the price back to $20.
The above example tells that sudden change in the price, whether increasing or decreasing, can create a market imbalance. That’s why change must be brought slowly.
Now, the role of Bollinger Band here is that it reflects the assumption. That means this indicator adapts to the dynamic price change. Then it forms three lines.
The middle line indicates long-term price change. Similarly, the other two lines show price fluctuations. Now, if the price of the commodity moves downwards, it means the item is getting cheap. Whereas, if it’s moving upwards, it shows that the item is getting expensive.
Long story short, with the help of Bollinger Bands, you can easily understand the market psychology and place winning trades.
What do Bollinger Bands tell?
The reason that Bollinger Bands is getting popular among traders is that it has simple concepts. Unlike other complicated technical trading tools, this one does not require you to have detailed market knowledge.
Simply by analyzing whether the market asset is overbought or oversold, this tool can help you. If the asset’s price in the market moves near an upward band, it shows overbought. Similarly, if it moves closer to the downward band, it indicates oversold.
Also, if the overbought and oversold actions are limited and the market is less volatile, then the band contracts. And the band widens if the market gets highly volatile.
Squeeze is a situation in Bollinger Bands that arises when the bands come too close. Squeezing in the trading market also indicates limited volatility.
Now, this situation is both profitable and risky. Several traders like to enter the market during this situation as it helps them win a better payout. Instead of moving close, if the band moves far, volatility gets limited. But trading opportunities do not decrease.
However, noticing this chance is really very difficult as the band does not give any signal.
Another common occurrence in Bollinger Bands is breakouts. It takes place when the price movement happens between two bands. Although it’s seen as a major event, it is not a trading signal. That means one must trade during breakouts using the Bollinger Bands strategy at their own risk.
How to calculate Bollinger Bands?
Calculating Bollinger Bands data is rather simple than complicated. The formulas and theories might feel like a little too much, but everything is easy to understand.
For the calculation, you need to check the moving average of 20 days. Here, the closing prices are termed as the first data point. Similarly, the next data point to the earliest price drop, i.e., the price of day 21 and the following days.
Here’s a simple formula for calculating Bollinger Bands.
BOLU is the upper Bollinger Band.
BOLD is the lower Bollinger Band.
MA is moving average.
TP is a typical price, i.e., (high + low + close) divided by 3.
n is the number of days in the smoothening period.
m is standard deviations.
σ[TP,n] is standard deviations of the last n period of TP.
How to trade with Bollinger Bands?
If you want to win a better payout, you must use Bollinger Bands trading strategy in three ways, i.e., bullish breakout, bearish breakout, and range market.
A bullish breakout is formed when the market price closes above the upper line in Bollinger. Similarly, during a bearish breakout, the price closes below the lower line. Lastly, during the range market, the price stays inside the range.
Reasons traders must use Bollinger Bands
If you are still not sure about using Bollinger Bands’ trading strategy, here are a few points that might convince you.
Using Bollinger Bands strategy can help you make more profit. That’s because, through this strategy, you can understand how far a trading market can move.
The derived predictions can further be used with binary options like one-touch options and ladder options.
New trading opportunities
You can identify more trading opportunities while using Bollinger Bands because this strategy shows how the trading market behaves.
Avoid bad trades
Not only can you identify better trading opportunities, but you can also avoid bad trades. Once you understand how the bands work and what they indicate, you can save yourself from losing money.
It is simple
Lastly, trading binary options using Bollinger Bands is simple because this tool can quickly analyze the market. That means one can do an overall binary market analysis in just a few seconds.
Limitations of Bollinger Band
Just like any other trading tool, this one also has certain limitations. Some of them are as follows.
- One cannot rely on all the given information by Bollinger Bands because it does not provide accurate data all the time.
- To get better results, you should use this technical tool with a few other indicators.
Bollinger Bands are an excellent trading tool that one uses for analyzing the market. This simple-to-use tool is perfect for both professional and newbie traders.
Once you have understood the right way of calculating Bollinger Bands, you can use it with different trading tools. Also, it’s suggested to use this strategy while trading with leading market brokers, like IQ Option, Binary.com, and RaceOption.