Congratulations on making it to the 5th grade! Each time you make it to the next grade you continue to add more and more tools to your trader’s toolbox.
“What’s a trader’s toolbox?” you ask.
Let’s compare trading to building a house. You wouldn’t use a hammer on a screw, right? Nor would you use a buzz saw to drive in nails. There’s a proper tool for each situation.
Just like in trading, some trading tools and indicators are best used in particular environments or situations. So, the more tools you have, the better you can adapt to the ever-changing market environment.
Or if you want to focus on a few specific trading environments or tools, that’s cool too. It’s good to have a specialist when installing your electricity or plumbing in a house, just like it’s cool to be a Bollinger Band or Moving Average specialist.
There are a million different ways to grab some pips!
For this lesson, as you learn about these indicators, think of each as a new tool that you can add to that toolbox of yours.
You might not necessarily use all of these tools, but it’s always nice to have plenty of options, right? You might even find one that you understand and comfortable enough to master on its own. Now, enough about tools already!
Let’s get started!
Bollinger Bands, a chart indicator developed by John Bollinger, are used to measure a market’s volatility.
Basically, this little tool tells us whether the market is quiet or whether the market is LOUD!
When the market is quiet, the bands contract and when the market is LOUD, the bands expand.
Notice on the chart below that when price is quiet, the bands are close together. When price moves up, the bands spread apart.
That’s all there is to it. Yes, we could go on and bore you by going into the history of the Bollinger Band, how it is calculated, the mathematical formulas behind it, and so on and so forth, but we really didn’t feel like typing it all out.
In all honesty, you don’t need to know any of that junk. We think it’s more important that we show you some ways you can apply the Bollinger Bands to your trading.
Note: If you really want to learn about the calculations of a Bollinger Band, check out John’s book, Bollinger on Bollinger Bands.
The Bollinger Bounce
One thing you should know about Bollinger Bands is that price tends to return to the middle of the bands. That is the whole idea behind the “Bollinger Bounce.”
By looking at the chart below, can you tell us where the price might go next?
If you said down, then you are correct! As you can see, the price settled back down towards the middle area of the bands.
What you just saw was a classic Bollinger Bounce. The reason these bounces occur is because
The reason these bounces occur is because Bollinger bands act like dynamic support and resistance levels.The longer the time frame you are in, the stronger these bands tend to be.
Many traders have developed systems that thrive on these bounces and this strategy is best used when the market is ranging and there is no clear trend.
Now let’s look at a way to use Bollinger Bands when the market is TRENDING…
The “Bollinger Squeeze” is pretty self-explanatory. When the bands squeeze together, it usually means that a breakout is getting ready to happen.
If the candles start to break out above the TOP band, then the move will usually continue to go UP.
If the candles start to break out below the BOTTOM band, then price will usually continue to go DOWN.
Looking at the chart above, you can see the bands squeezing together. The price has just started to break out of the top band. Based on this information, where do you think the price will go?
If you said up, you are correct again!
This is how a typical Bollinger Squeeze works.
This strategy is designed for you to catch a move as early as possible.
Setups like these don’t occur every day, but you can probably spot them a few times a week if you are looking at a 15-minute chart.
There are many other things you can do with Bollinger Bands, but these are the two most common strategies associated with them. It’s time to put this in your trader’s toolbox before we move on to the next indicator.