DAY 11: Bollinger Bands – Understanding Volatility
Last time (DAY 10) we learned the mechanics and applications of MACD.
This time,we will cover the Bollinger Bands, a famous indicator that visualizes the market's “volatility (range of price fluctuations).” Bollinger Bands are used to visualize how far prices are from the average.
Bollinger Bands are versatile for both trending and range-bound markets, making them popular among beginners to advanced traders.
Let’s quickly look at how they work and how to use them!
1. What are Bollinger Bands?
- Developer: John Bollinger
- Basic structure: Draw bands by adding/subtracting standard deviation
- Typical display: Multiple bands such as ±1σ, ±2σ, ±3σ are plotted on the chart, and volatility is judged by where prices sit relative to these bands.
(1) What is standard deviation?
- A measure of dispersion derived from historical price movement (such as closes).
- If price moves are large, standard deviation increases and band width widens.
- If price stays in a narrow range, standard deviation decreases and band width narrows.
2. Meaning of ±σ (sigma)
(1) ±1σ (about 68%)
- Bands are drawn by adding/subtracting 1σ from the moving average.
- Historically, price is within the ±1σ range about 68% of the time.
(2) ±2σ (about 95%)
- Commonly used is ±2σ.
- Prices are within ±2σ about 95% of the time, making it a reference for contrarian strategies used by many traders.
(3) ±3σ (about 99.7%)
- Prices reaching ±3σ is statistically rare.However, in extreme “band-walking” market conditions (explained later), reaching these levels can occur, so beware.
3. Squeeze & Expansion
(1) Squeeze
- The Bollinger Band width narrows tightly.
- Volatility is decreasing = a sign that energy is building and a big breakout often follows.
- A common strategy is to wait for a squeeze and then prepare to enter on the breakout.
(2) Expansion
- Band width expands rapidly.
- Volatility spikes = price is starting to move strongly.
- There is a high likelihood of a strong trend forming, and a phenomenon called “band-walking” may occur.
(3) Band-walk
- Price continues to move along the outer bands, such as ±2σ or ±3σ.
- Generally, the contrarian rule is to expect a reversal when touching ±2σ, but during strong trends, prices may touch and continue along the outer band, causing large losses.
- In other words, you should consider not only contrarian trading, but also riding the trend by band-walking.
4. Representative Bollinger Bands trading strategies
(1) Contrarian strategy
- Price touches (or breaks beyond) ±2σ or ±3σ
- Judge the market as overextended and enter contrarian trades aiming for a rebound
- Place stop loss slightly beyond the outer band in case of further band-walking
- Take profit near the moving average or near ±1σ
Note：
- In an uptrend, contrarian buying near -2σ may be effective, but contrarian selling near +2σ carries risk of a squeeze.
- Check whether there is a strong trend using the slope of the moving average and other indicators (MACD, etc.).
(2) Trend-following strategy (breakouts or band-walking)
- SqueezeLater, the bands expand rapidly, and price starts moving beyond the outer band
- This indicates a surge in market volatility and a high likelihood of a trend forming
- Enter with a breakout-focused trend-following entryand ride the band-walking trend
- Having clear rules to exit when price returns inside the bands helps minimize losses
(3) Using with other technicals
- Rather than relying on Bollinger Bands alone, many traders use MACD or RSI to confirm trend or momentum when narrowing down entries.
- In discretionary trading, targeting points where “±2σ touch + RSI is oversold” or similar multi-condition setups increase reliability.
5. Advantages & Disadvantages of Bollinger Bands
Advantages
- Visualizing volatility
- Squeezes suggest “likely next big move,” expansions suggest strong momentum.
- Supports both contrarian and trend-following strategies
- Can target contrarian trades using ±2σ, but can also aim for trend-following along band-walk.
- Flexible settings
- Defaults are often 20 periods and ±2σ, but you can adjust the period and standard deviation to fit your trading style and timeframes.
- Defaults are often 20 periods and ±2σ, but you can adjust the period and standard deviation to fit your trading style and timeframes.
Disadvantages
- Contrarian trading in a strong trend is risky
- If you think price has gone too far and trade against the trend, you may get crushed by a band-walk.
- Over-tuning or excessive customization may lead to confusion
- Over-optimizing periods or σ to past data may not perform in real-time trading.
- Difficulty judging the timing of a rebound
- Touching the band is not always the best entry; there may be another push.
- Consider delaying entry or using staggered entries to manage risk.
6. Summary & Next Preview
Summary
- Bollinger Bands visualize price volatility around a moving average, making them an excellent indicator.
- The sequence squeeze → expansion suggests market energy filling and releasing, creating favorable breakout opportunities.
- Contrarian strategies target rebounds at ±2σ or ±3σ, but strong trends carry risk of significant moves via band-walking.
- Additionally, combining with other technicals and price action and choosing between contrarian or trend-following based on the situation is key.
Next time (DAY 12) topic: Ichimoku Kinko Hyo – Japan’s born comprehensive analysis tool
- Finally, we will cover the comprehensive indicator Japan is proud of,Ichimoku Kinko Hyoand how to use it to understand trends and market strength.
- Each element (baseline, conversion line, cloud, etc.) will be explained to understand how to assess trend and market strength.
- Ichimoku, highly regarded overseas, is deep enough that both discretionary traders and algos use it. Look forward to it!
If you’re interested in automated trading, please also check the link below.
https://www.gogojungle.co.jp/users/147322/products
If this was helpful, I’d appreciate it if you click “Read more.”
Thank you.
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