How to Use Bollinger Bands to Trade Stock & Binary Options

The bollinger bands are adaptive trading bands that indicates changes in volatility and provide a better view of the true extent of the price action.

Developed by John Bollinger in the 1980s, the Bollinger Bands indicator works on the mathematical theory that statistically, 95% of the time, prices will stay within the standard deviation from the mean.

Constructing the Bollinger Bands

There are 3 components to the bollinger bands indicator. There is the upper band, the lower band and the middle band.

First, a 20 period simple moving average of the asset price is computed. This value is represented by the middle band.

The upper and lower bands are then calculated by using two standard deviations from the middle band.

Overbought & Oversold Levels

When the underlying asset price touches or breaches the upper bollinger band, the asset is said to be overbought. When this happens, the trader can potentially look into going long or buying a call option.

When the asset price touches or breaches the lower bollinger band, the asset is said to be oversold. When this occurs, the trader can take it as a signal to short sell the underlying or buy a put option.

Support & Resistance Levels

The upper and lower bands can also act as resistance and support levels respectively.

Traders generally avoid going long or buying calls when the asset price hits the upper bollinger band.

Similarly, traders often avoid going short or buying puts whenever the asset price hits the lower bollinger band.

Volatility Indicator

The Bollinger Bands are also a great tool to use for determining whether the market volatility is currently high or low.

When market volatility is high, the bands expand. When market volatility is low, the bands contract.