Bollinger Bands are a technical indicator that were developed by John Bollinger back in the 1980s. The idea behind the bands was to give some sort of an indication of the standard deviation of the current price in relation to the previous prices. In that respect, they are a volatility indicator as they use standard deviations as an input.
Ever since then, Bollinger bands have been a staple indicator that traders have used for a number of different asset classes. They are usually used in combination with other indicators such as trend levels and volume.
Given that Binary Options provide the investor the opportunity to enter a trade with a known downside, using Bollinger Band strategies to trade them can be quite profitable.
What is a Bollinger Band?
Bollinger bands is an indicator which defines the middle trend of a stock based on the time period which you have set. For most charts online, this is the 20 period moving average. This is usually calculated as a simple moving average although some charting software may provide the option for an exponential moving average.
Once this has been plotted, the upper and lower Bollinger bands are calculated by adding a chosen standard deviation to this moving average. This standard deviation is a statistical calculation of the variance of the asset around the mean.
Below is a chart of EURUSD and the Bollinger bands around it. Notice how the upper and lower bands are an indicator of volatility around the mean.
EURUSD Bollinger Bands
Bollinger Band Strategies
Due to the fact that Bollinger Bands combine moving average indicators with a measure of volatility and trend, the trader is able to get a sense of whether the asset is in an overbought or oversold level.
When first introduced, traders used the bands to provide signals of how far away the price was from the prevailing trend. This meant that they would usually choose to short the asset if it touched the upper band and go long the asset if it hit the lower band.
This strategy used to work well when the asset was trading in a range bound fashion when it would hit the lower and upper bands as if it were “bouncing off the walls”. The main problem with this is that touching the band should not be in and of itself an indicator of action.
Occasionally, the asset tends to “walk” one of the bands. This means that if a trader is continually trying to enter a position either long or short and the asset stays along the band, it could impact on his returns.
This is where the more advanced Bollinger Band Binary Option strategies like those below can help you.
Bollinger Band Squeeze
As with a normal triangle formation in technical analysis, the Bollinger band squeeze attempts to spot periods of heightening tension in the price. The hope is that eventually the asset will recoil and breach the squeeze. An indicator of the squeeze factor is given by the Bollinger band width. This is calculated as the difference between the upper and lower bands divided by the middle band.
The main idea behind the Bollinger Band squeeze is to monitor this Bollinger Band width. Once this indicator reaches a low, then one can expect volatility to once again increase and potentially widen the bands. Given that Binary Options are best used in volatile conditions, this could be a profitable Binary Options trade.
If you wanted to confirm your views on the band width expansion, then you could use other indicators of impending pressure including increasing volume or positive accumulation / distribution.
Taking a look at the below example, you can see that the narrow band width of the Australian dollar. This reaches it’s lowest point before eventually breaching the bands with candles closing outside of it.
AUSUSD Squeeze Trade
This should be a good indication that the pent up energy built up in the squeeze before breaching. The Binary Options trader should enter a PUT option with a 1 hour expiry to make the most of the decrease in the Aussie dollar.
Bollinger Band Double Tops / Bottoms
One of the most well-known formation trading strategies is that of the double top / bottom. This strategy usually analyses two bottoms / tops. If this formation is identified correctly, then an automatic rally or selloff is usually expected. However, the inclusion of the Bollinger bands in the analysis has proved extremely beneficial for the traders.
Given that Bollinger bands give an indication of the volatility, the trader can examine the points of the double top / bottom in relation to the boundaries of the band. If the second point in the double top / bottom is struggling to close outside of the band, then this is an indicator that the formation has been well identified.
The trader must look out for the first bottom / top. This is either a pullback or rally that breaches the bands on high volume. Once this has been identified, the trader needs to keep tracking the movement of the asset. If the price breaches the band again and is below the first part of the formation then this is the second point.
Once you have identified this second part of your double top / bottom, then you need to determine whether the price will eventually rally or selloff. This is usually established by taking a look at the trading volume at this second point. If the volume is considerably below that first point then the trader can either go long or short. This would involve either entering a CALL or a PUT.
In the below chart, we have GBP/USD or “cable”. As we can see the first bottom of the double bottom has been formed outside of the lower band. The trader should then monitor the performance of the pair and the volume to spot the second bottom.
GBPUSD Double Bottom Trade
As we can see, the second bottom has formed at a lower low and with at least 30% less volume. This implies that the downward trend is about to dry out and a pickup in cable is imminent. This would mean the Binary Options investor would go long a CALL option. In this case, the trader should wait until the pair reaches the upper band before deciding to exit.
Bollinger Band Reversals
This is a Bollinger band strategy that makes use of some candlestick analysis in order to confirm a view. The candlestick analysis will help the trader by confirming their view on placing a trade.
For example, assuming that the price has gaped down below the bottom Bollinger band. In this case, the standard trade would be to go long the asset in the expectation of a reversal. However, there is always the possibility that the reversal may take quite a bit longer in order to manifest itself.
This is where the analysis of the respective candles serves helpful. If the candle that breached the lower boundary has a closing price that is near the high of that respective candle, then that is a positive indicator. In this case, the trader can go long the asset and enter a CALL option.
This can also be used to short an asset that has breached the upper boundary of the Bollinger band. The option expiry should be determined in relation to your chart’s candle interval. If the option entitles you to an early exit, then you should consider a possible exit level. Typically, the Bollinger band levels are used as appropriate retracement and exit levels.
Taking a look at an example, below we have the chart of Spot Gold. As we can see, the price has breached the upper band. The second candle however, has closed down and the closing price is near the low of the interval.
Spot Gold Reversal Trade
This is a good indication that Gold would be ideal to short. The Binary Options investor should therefore enter a PUT option with a 30 min expiry. This would allow the trader to profit from the retracement in the price of the pair.
Bollinger Band Continuation Trading
New traders who use Binary Options with Bollinger Bands tend to make the same mistake. They place a CALL or PUT option going long or short the asset the moment that it appears to touch one of the bands. This can be a short-sighted way of trading. As we have mentioned above, there are many occasions in which an asset does not always reverse and on some occasions continues.
These continuation patterns could also be an opportunity for the trader to make a profit by entering positions in the same direction. This will also require an analysis of technical indicators such as volume. If an asset has breached it’s Bollinger bands take a look at the volume that is forming.
If the volume appears to be increasing with each time step and the price of the asset is closing at higher highs, this is a strong bullish indicator. The same can be said for continuation and band riding trades to the downside.
You can also use the middle Bollinger band or moving average line as a support or resistance level of your trade while riding the band. It is also very important to monitor the volume of prior to placing your trade. If there appears to be a slowdown in the trend demonstrated by lower volume then this is usually a good time to close out your trade and realise and profits. If your Binary Option does not allow early exit then it is advisable to choose a short time period which corresponds to your chosen intervals.
A good example of an opportunity to ride the Bollinger band was the recent daily performance of USD/JPY. In the below chart, we have the 5 minute interval of the pair. We can see price first breaching the upper band just after the previous squeeze.
USD/JPY Band Riding Trade
A novice investor would merely short the pair on the assumption that it would return within the bands. However, an experienced investor would have been able to spot the increasing volume and price in the next few candles. This would be the ideal situation for the trader to profit from the rally in the price.
In this case, a CALL Binary Option with a 1 hour expiry would be the best trade to make.