The construction of Bollinger Bands
Bollinger Bands is the name of the indicator that determines the extent of changes in asset price. Its construction is essentially based on three moving averages. One in the middle, the other two are on both sides of the former. The width of the range is measured using the mathematical formula of standard deviation.
In the indicator settings, you will find the button to customize the Bollinger Bands coefficient. The range expands as the coefficient increases. You can observe then that the price doesn’t reach upper and lower bands so often.
The period is the total amount of candlesticks that are used to specify the parameters of the indicator. The corridor will be smoother as the period increases. However, it does not mean the accuracy of the indicator will increase as well.
Bollinger Bands and the price movement
Whenever the price is touching or nearing one of the outer averages, the most probable scenario is a change in price direction.
If the price breaks the line and goes beyond it, you can expect the beginning of the trend in the direction of the breakout.
The corridor will be wider as the market volatility increases.
If the price is moving in a narrow corridor for a long time, it is usually a sign of market consolidation before a strong price movement.
The best thing to do is to use the Bollinger Bands together with another indicator. The confluence of two different technical indicators can make your trading signals more accurate.
You can read more about BBands in our articles about connecting Bollinger Bands with pin bars and about combining Relative Strength Index with Bollinger Bands.
Pros and Cons
Here are the advantages and disadvantages of using Bollinger Bands for asset price analysis:
- 👍 Pros:
- Provides a visual representation of price volatility and potential trend reversals
- Helps identify overbought and oversold conditions in the market
- Can be combined with other indicators for more accurate trading signals
- 👎 Cons:
- Not always effective in choppy or sideways markets
- Signals may lag behind significant price movements
- Requires understanding and interpretation of standard deviation and moving averages
Q&A on Bollinger Bands
- Q: What is the construction of Bollinger Bands based on?
A: Bollinger Bands are constructed based on three moving averages and the mathematical formula of standard deviation.
- Q: How can Bollinger Bands help predict price movements?
A: When the price touches or nears one of the outer averages, it indicates a potential change in price direction. Additionally, if the price breaks through the upper or lower band, it may signal the beginning of a trend in that direction.
- Q: How does the period setting affect Bollinger Bands?
A: The period setting determines the number of candlesticks used to calculate the indicator’s parameters. A higher period value results in a smoother range, but it doesn’t guarantee increased accuracy.
- Q: How does market volatility impact Bollinger Bands?
A: The band width expands with increased volatility, indicating a wider price range. Conversely, narrow bands suggest market consolidation before a potential price movement.
- Q: Can Bollinger Bands be used with other indicators?
A: Yes, combining Bollinger Bands with other indicators can enhance the accuracy of trading signals. For example, Bollinger Bands can be used in conjunction with the Relative Strength Index (RSI) for more comprehensive analysis.
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