Bollinger Bands® are a powerful technical analysis tool that helps traders gauge market volatility and predict price trends. This guide explains the overlaps and divergence of Bollinger Bands. Learn how to optimise your trading using Bollinger Bands and enhance your trading strategy with additional technical tools.
Since starting our series on Bollinger Bands®, we have come a long way.
We started with an introduction to the concept and key features of this tool in Bollinger Bands - Introduction and key points. We progressed to learn how to use Bollinger Bands® to help map out our trading strategies for long and short positions. In our last article we looked at how to use the trends observed with Bollinger Bands to determine when to enter a trade and when to exit a trade. Do check out these articles if you just started on Bollinger Bands and would like more background on this technical analysis tool.
In this article we are delving into another aspect of this tool that measures how volatile the market for an asset is - Overlaps and divergence.
1. Overlapping short-term and long-term Bollinger Bands
Bollinger Bands are a dynamic indicator where the width of the band changes with price movements and can be used to identify buy and sell points.
While many are familiar with using moving average (MA) crossovers to analyse buy and sell points, some methods combine MAs and Bollinger Bands (BB), or even different Bollinger Bands.
Some may be unfamiliar with the analysis method involving combinations of Bollinger Bands, but its creator John Bollinger enjoys using it. Compared to combining different MAs or MAs with Bollinger Bands, this method is less prone to false signals and delivers a clear view of trend developments.
The specific method overlaps the 20-day short-term BB with the 50-day long-term BB.
On the chart, both the MA line and the three lines representing ±2σ (a fundamental display by John Bollinger) will be shown simultaneously.
Figure 1. Overlapping Bollinger Bands on MT5
Figure 1 shows overlapping 20-day (blue) and 50-day (red) BBs.
Some forex charting software may not be able to display multiple Bollinger Bands, but it is easily achievable on MT4/MT5 by simply inserting them twice on the chart.
2. Band overlap and trend determination based on divergence
When observing Bollinger Bands crossovers, it is essential to pay attention to the overlap and divergence of the two bands. When the short-term and long-term +2σ bands overlap, and one band diverges to -2σ, it indicates an upward trend. Conversely, when the short-term and long-term -2σ bands overlap and the +2σ bands diverge from each other, it suggests a downward trend.
Figure 2 below illustrates the situation where there is an upward trend in the middle, with an overlap of +2σ and a divergence of -2σ.
Figure 2. Divergence on Bollinger Bands
Summary
In summary:
When Bollinger Bands diverge (move apart), it often signals that the current trend will continue.
This presents opportunities for trend-following traders to enter positions.
When the upper and lower bands overlap, it indicates the market is ranging (no strong trend) or entering a consolidation phase.
This phase is when traders are watching the market to prepare for the next move.
Bollinger Bands is a powerful technical analysis tool which changes its bandwidth with price movements. If you recall, in one of our previous articles, we touched on the subject of the four main characteristic patterns: Squeeze, expansion, band walk, and max bandwidth. It is useful to note that these patterns can be used to complement the concept of overlaps and divergence which we discussed today.
Other than Bollinger Bands, you could also explore other tools such as the correlation tool, currency strength tool and the simple moving average tool. These are just a few of the plethora of resources that can help you improve your trading performance.
Besides tools and research, if you find yourself lacking in trading ideas, you can always visit our very own OANDA Prop Trader Community. This community is the place for you to learn from experts and be inspired by other traders’ successes. When you join the community, you'll not only get trade ideas, but you'll also earn points that you can use to redeem rewards.
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