Bollinger Bands — Measuring Volatility
How to measure volatility, find extremes, and build strategies with Bollinger Bands.
What are Bollinger Bands?
Bollinger Bands is a widely used technical indicator developed by John Bollinger, which serves to measure the volatility of financial instruments' prices.
It consists of a set of three lines: a central one, which is a simple moving average, and two outer bands located at a distance of two standard deviations from the central one. These bands form a dynamic channel that helps traders visualize the range of expected price fluctuations.
Thanks to its adaptability to different market conditions and assets, Bollinger Bands are a universal tool for a wide range of traders.
How Bollinger Bands are calculated
For trend trading, the band is calculated as a 20-day simple moving average (SMA).
- Middle Band = 20-day simple moving average
- Lower Band (LOWER_CROSS) = (20-day standard deviation of price × 2) + 20-day simple moving average
- Upper Band (UPPER_CROSS) = 20-day simple moving average – (20-day standard deviation of price × 2)
- SMA is calculated as the sum of closing prices for n periods / n (in this case n = 20)
Indicator Settings
When using the Bollinger Bands indicator, traders have the opportunity to set two important parameters:
- Timeframe (Period): defines what time interval is used to calculate the middle line (e.g., 5 minutes, 1 hour, or 1 day).
- Standard Deviation (StdDev): shows how far prices can move away from the average value. The default value is 2.
You can also change the type of average and the calculation period.
How to use Bollinger Bands
On different assets, the period and the standard deviation multiplier need to be adjusted to the current volatility. Given each asset's volatility, you will likely have to change the period and standard deviation multiplier settings often.
Channel boundaries are used to open positions:
- LOWER_CROSS is used to open LONG positions.
- UPPER_CROSS is used to open SHORT positions.
Setting Recommendations
- Low volatility assets: StdDev = 2.0–2.5
- High volatility assets: StdDev = 2.5–3.5
You can read about what volatility is here
Advantages and Disadvantages
| Advantages | Disadvantages |
|---|---|
| The tool is applicable on all time intervals; however, to get more reliable signals, it is recommended to refrain from using very short periods as they are subject to strong random market fluctuations. | The SMA used makes the indicator lagging. |
| With correct settings, it adapts to any instrument regardless of volatility. | Does not generate specific signals, requires analysis. |
| Setting flexibility allows adapting the indicator to specific tasks. | More often used as an auxiliary tool rather than a standalone signal source. |
Trading Strategies
To create an effective strategy on the Intelligent Investment Network (IIN) platform, it is important to understand that Bollinger Bands show volatility and price levels, but do not always accurately determine trend strength or reversal points. Therefore, they are used in combination with other indicators.
Using Stochastic Oscillator and EMA together with Bollinger Bands is a classic way to create a "three-confirmation system". In such a connection, each indicator performs its role:
- Bollinger Bands: Determines volatility boundaries and the "road" of the price.
- Upper band: potential overbought zone.
- Lower band: potential oversold zone.
- Stochastic: Works as an oscillator for finding reversal points.
- Confirms that the price is indeed ready to reverse from the Bollinger boundary.
- EMA: Filters market noise and shows global trend.
- Helps not to open deals against the main market movement.
1. Bollinger Bands + Stochastic
This strategy is ideal for a sideways market or moderate trend.
- Buy signal (Long):
- 1. Price touches or breaks the lower Bollinger band.
- 2. Stochastic enters the zone below 20 (oversold) and its lines ($%K$ and $%D$) cross from bottom to top.
- Sell signal (Short):
- 1. Price touches or breaks the upper Bollinger band.
- 2. Stochastic enters the zone above 80 (overbought) and its lines cross from top to bottom.
2. Bollinger Bands + EMA
EMA crossover inside the channel is a strong signal of trend continuation or change.
- Golden cross: EMA 9 crosses EMA 21 from bottom up — growth signal.
- Death cross: EMA 9 crosses EMA 21 from top down — decline signal.
- Advantage: EMA reacts faster than SMA 20.
3. Three-Confirmation System
The combination of Bollinger Bands, Stochastic, and EMA allows building a complete trading system.
- Trend filter: price above EMA 200 — work only in long.
- Setup: price touches the lower band.
- Confirmation 1: stochastic crosses below 20.
- Confirmation 2: EMA 5 crosses EMA 13 from bottom up.
Practice on the platform
On the Intelligent Investment Network platform, try running a backtest with the following parameters:
- Bollinger Bands: (20, 2)
- Stochastic: (14, 3, 3)
- EMA: 9 and 21