Bollinger Bands® are a powerful technical analysis tool that helps traders gauge market volatility and predict price trends. This guide explains how to use Bollinger Bands for long and short positions, including key strategies such as the Bollinger Band Walk and identifying contraction and expansion phases. Learn how to optimise your trading decisions using Bollinger Bands and enhance your trading strategy with additional technical tools.
Bollinger Bands® are a technical analysis tool that uses a Simple Moving Average (SMA) to measure and quantify how volatile a trading instrument is. This can tell traders a lot about how the price will move and what the future trends will be for the asset.
If you would like to learn about the basics of this useful tool, head over to our previous article on Bollinger Bands - Introduction and key points. In this article we are going to discuss how we can use this tool to help us map out our trading strategies for long and short positions.
1. Key points for long and short trades
In trading, there are two types of trades: long positions and short positions. A long position involves buying or “going long” in anticipation of the upward market trend continuing. Conversely, the opening of a short position means that the trader expects the market trend to reverse, so it involves selling, or “going short”.
Bollinger Bands can be used to implement both long and short strategies.
When the candlestick breaks through the bands, you anticipate that the market trend will continue. In this case, you would adopt a long position (see Figure 1, A). Conversely, when you anticipate a market reversal, you would take a short position (as in Figure 1, B, C).
However, when the candlestick reaches ±2σ, determining whether to take a long or short position becomes more challenging. Therefore, it is essential to consider changes in bandwidth as an indicator. Specifically, using the repeated contraction and expansion of the bands to determine the trend.
Figure 1. Long and short positions
2. Long positions and expansion
The basic strategy recommended by John Bollinger, who developed Bollinger Bands, is to take long positions. When the candlestick crosses through ±1σ and ±2σ during a contraction phase, it marks the start of expansion. By taking long positions from the contraction phase to the expansion phase, you can benefit significantly from the subsequent price movement trend.
During the expansion phase, the candlestick appears to move along the ±2σ line. This phenomenon is also known as a Bollinger Band Walk. The expansion phase offers traders opportunities to enter long positions when the price bounces off the upper band. Conversely, when the price moves below the middle band, traders would exit their long positions. As long as this condition persists, profits may continue to be made.
Figure 2. Timing of long positions (from contraction to expansion)
3. Short positions and expansion
While long positions are taken during the period from contraction to expansion, short positions would be taken when the bands start to narrow. When the band narrows, it would be time to close out long positions or enter orders in the opposite direction. However, how would we know when the bands start to contract?
The key to determining when the bands are starting to contract is by observing how the channel changes on the opposite side of the candlestick trend.
When the channel on the opposite side reverses direction, it is a signal to close out or enter orders in the opposite direction. At position A in Figure 3, you can see the channel on the opposite side of the candlestick trend changing, and at the same time, the uptrend starts shifting to a downtrend.
Figure 3. Observing channel changes on the opposite side of the candlestick trend
You can easily set up Bollinger Bands on the MT5 platform. When setting up Bollinger Bands in MT5, do note that you can only set one standard deviation in the parameter settings screen. If you wish to learn how to set up Bollinger Bands on the MT5 platform and display other standard deviations simultaneously, do read the article Bollinger Bands - Introduction and key points.
If you would like to check out the other tools available for your technical analysis, do visit the technical analysis section of our blog.
Summary
The basic strategy recommended is to take long positions. In a long position, when the candlestick crosses through ±1σ and ±2σ during a contraction phase, it marks the start of expansion. By taking long positions from the contraction phase to the expansion phase, you can benefit from the subsequent trend. During this expansion phase, the candlestick appears to move along the ±2σ, which is known as a Bollinger Band Walk. When the expansion narrows, it is time to close out long positions or enter orders in the opposite direction.
If you need more tools to complement your trading strategies, besides Bollinger Bands, you can also explore other tools such as the order and position book, currency strength meter, correlation tool, and sentiment tool. You can improve your trading performance by using these technical analysis tools as part of your trading plan.
Along with tools and research, the key to making profit in trading is consistently coming up with good ideas. In this aspect, working with other traders and sharing your thoughts can help you learn more about trading. Talking to other people in forums and groups can help you see things from different angles and come up with new plans. It can also help you find new opportunities in different pairs and instruments.
If you want to find other traders who are like you, why not join our brand-new OANDA Prop Trader Community? When you join the group, you'll not only get trade ideas, but you'll also earn points that you can use to redeem rewards. Join our community now so you don't miss out.
