Bollinger Bands® are a powerful technical analysis tool that helps traders gauge market volatility and predict price trends. This guide discusses how to determine when to enter and exit a trade, how to take profit and stop loss. Learn how to optimise your trading decisions using Bollinger Bands and enhance your trading strategy with additional technical tools.
In our previous article we delved into the four main patterns of Bollinger Bands® Squeeze, expansion, max bandwidth and bandwalk to help determine changes in or the continuation of the price trends of an asset. If you would like a refresher on this technical analysis tool that measures how volatile the market for an asset is, do head over to our previous article on Bollinger Bands - Introduction and key points.
In this article we will discuss how to use the trends observed with Bollinger Bands to determine when to enter a trade and when to exit a trade.
1. Trade in the direction of breakouts
The developer of the Bollinger Bands, John Bollinger, believes that the central MA line and the ±2σ chart are essential for analysis. However, in practical usage, traders often incorporate the ±1σ with a combination of 5 lines. Understanding the ±1σ can help implement the following buy and sell strategies.
Trading Method Using ±1σ
The advantage of this method lies in its ability to clearly identify entry points, making it easy to use even if you are just a beginner trader.
In this strategy, when the price reaches ±1σ, it shows a trend in that particular direction, allowing for trading with the trend. When using this method to enter a trade, the exit-point of the trade will be ±2σ.
In Bollinger Bands, the probability of the closing price falling within the ±2σ band is about 95%. Conversely, this means that there is a very low probability of the closing price exceeding ±2σ. Therefore, it is advisable to exit the trade and take profit when the price reaches ±2σ.
In short:
When the price breaks through the MA line to +1σ, we get a buy signal.
When the price breaks through the MA line to -1σ, we get a sell signal.
Figure 1. Entry Point and Take-Profit
When it comes to closing positions using a take profit (TP) or stop loss ( SL) order, it is advisable to do so when the width of the band begins to narrow. The key in determining this is not to focus on the ±2σ on the side of the candlestick movement but on the ±2σ on the opposite side. It is timely to close your positions when there is a reversal in the band's direction.
Specifically, in Figure 1, when the width starts to narrow at position B, it is time to close your short positions.
2. Using MA lines to determine stop-loss levels
After entering a trade, the market trend may reverse before reaching the take-profit target of ±2σ. In such cases, the stop-loss should be set at the level where the trend retraces to the MA.
Buying at +1σ and closing at ±2σ, or selling when reaching the MA line, is a straightforward method that can be executed easily. However, volatility may cause price ranges to differ slightly, so caution is necessary.
Figure 2. Determining stop loss
Summary
In summary:
When you implement the trading method of using ±1σ, your exit-point of the trade will be ±2σ. If the market trend reverses before reaching the take-profit target of ±2σ, the stop-loss should be set at the level where the trend retraces to the MA.
Bollinger Bands® are a technical analysis tool that uses a Simple Moving Average (SMA) and standard deviations to track the price trend (confirming market direction) and volatility.
The characteristic feature of Bollinger Bands is their ability to capture changes in volatility dynamically as the bandwidth changes with price movements. The range of the band exhibits squeeze or expansion properties, which helps you to identify the starting and ending of trends. This helps you determine when to enter or exit a trade.
Apart from Bollinger Bands, there are many other tools you can explore, such as correlation tool, sentiment tool, and currency strength tool. By incorporating these technical analysis tools as part of your trading plan, you can enhance your trading performance.
Besides tools and research, other factors that may help you become a successful trader include motivation and discipline. Motivation is often found when you engage with fellow traders like yourself. Interacting with other traders can sharpen your skills and motivate you in your prop trading journey. A good community of traders may just make a difference to your success as a prop trader.
If you want to find likeminded traders, why not join our OANDA Prop Trader Community? When you join the group, you'll get to participate in discussions, obtain expert insights, and also earn points that you can use to redeem rewards.
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