Bollinger bands are an effective and easy indicator of technical analysis to create a binary options strategy. Learn more about trading Bollinger bands here in our article.
What are Bollinger bands?
Bollinger bands are a technical indicator that can help you evaluate whether the current market price of an asset is high or low and how far this asset’s price can move.
For this purpose, Bollinger bands create a price channel that consists of three lines: a middle line, an upper limit, and a lower limit. Bollinger bands predict that the market will stay within the upper and lower extreme. Whether the market is currently trading above the middle line can tell you whether the asset is in an uptrend or a downtrend.
Bollinger bands consist of a moving average, most commonly a simple 20-period moving average. In the picture below the moving average is the middle green line. From this moving average, an upper and a lower band are calculated by multiplying the standard deviation by a factor, most commonly 2.
These standard settings create an accurate potential for how far the market can move at any given time.
- Even in an uptrend, the market is unlikely to move beyond the upper line of the Bollinger bands.
- Even in a downtrend, the market is unlikely to move beyond the lower line of the Bollinger bands.
- In the long term, the market is likely to return to the middle line.
With these three lines, Bollinger bands create a price channel around the current price movements. In relation to the current market price, this channel creates a number of signals you can use for your trading.
First of all, Bollinger bands you to get a feeling for whether prices are currently high or low.
Without Bollinger bands, price movements are sometimes hard to judge. The market seems to move somewhat out in the open. Since there is no system to measure these movements against, many traders, especially newcomers, find it difficult to determine whether prices are currently high or low and whether or not a movement is likely to continue.
Most fundamentally, Bollinger bands define a trading range prices are unlikely to move out of. By measuring current price movements against this trading range, you know whether prices are currently high or low.
- The closer prices are to the upper end of the range defined by the Bollinger bands, the higher they are.
- The closer prices are to the lower end, the lower they are.
When the market is in a trend, you can use Bollinger bands to predict the next consolidation. When the movement gets close to the upper or lower end of the Bollinger bands, you can expect the movement to weaken and consolidate before the next period creates new values for the Bollinger bands and provides the market with more room to move again. `
Of course, it is possible for the market to move outside of the Bollinger band’s range. When the market has moved outside of the Bollinger bands, it is highly likely to move back in soon. So even if you lose a trade because you predicted the market will stay inside the Bollinger bands, but it moved outside, you can easily win another trade by predicting that the market will move back within the range. Just make sure to choose an expiry that is at least as long as one period of your current chart but not longer than two periods.
Many traders combine Bollinger bands with momentum indicators such as the relative strength index (RSI). These indicators are ideal to find weakening movements and can help you to validate the predictions made by the Bollinger bands.
Trading Bollinger bands with binary options
There are plenty of ways in which you can use Bollinger bands for your trading, either by trading them directly or indirectly.
Firstly, the upper Bollinger band can be treated as a resistance level and the lower band as a support level. When the market moves close to the upper band, you know it will likely turn around and not break the band. When the market moves close to the lower band, it will likely do the same. Additionally, the moving average forms a resistance or a support level depending on which side of the price it is on.
You can use this information for your trading:
- When the market is approaching a line, you can invest in a No Touch option with a trigger price well on the other side of the line. The line will likely force the market to turn around and keep it from touching the trigger price.
- You could also invest in a High / Low option in the opposite direction of the line. If the line is above the current price, it will work as a resistance, and you can invest in a Low option, predicting that prices will turn. Vice versa you can do the same thing with a High option when the line is beneath the market and works as a support.
- If you are trading with Nadex or a broker that offers ladder options, you could invest in a low option with a strike price outside the upper Bollinger band or in a high option with a strike price outside the lower Bollinger band. With this strategy, you should be able to win a high percentage of your trades, which makes it ideal for risk-averse traders.
As a trader with a trend-based strategy, Bollinger bands can help you find limiting areas for your trend. For example, when you are trading a trend in an hourly chart, you can take a daily chart’s Bollinger band as an indication of which trend direction is more likely to occur. When the price on the daily chart is near the top of the trading range defined by the Bollinger bands, you know it will likely fall. Therefore, you should only invest in downtrends in the hourly chart, as there is too little room for an uptrend to develop.
With candlestick formations, you should take a similar approach, and only trade formations in the direction indicated by the Bollinger bands. When prices are near the lower trading range of the Bollinger bands, for example, you should only invest in Candlestick formations indicating rising prices. Vice versa, when prices are near the upper trading range, you should only invest in Candlestick formations indicating falling prices.
Example strategies for binary options with Bollinger bands
In the previous part of this article, we looked at a few examples of how you can use binary options to trade Bollinger bands. Let’s take things one step further and see how you can include Bollinger bands into a fully developed strategy.
Example 1: Using Bollinger bands to filter trends
We have written extensively about trend analysis and strategies based on trends. If you are unfamiliar with trend-following strategies, here is the quick rundown: when the market moves up and down, it never moves in straight lines. It moves in little zig zag movements, taking two steps forward and one step back. These zig zag movements are called trends.
Trends necessarily involve a few consolidation periods because it is simply impossible for the market to rise continually. Sometimes, the market has to pause and generate new momentum before it can resume its original direction.
Trends are patterns that are easy to recognize. Consequently, many traders use them for their trading. By predicting that a trend will continue, you can find profitable trading opportunities and win a high percentage of your trades.
Of course, every trend will end eventually. Consequently, binary options traders always worry whether a trend still has some has left in the tank or is going to end soon. Bollinger bands can help you to make this prediction.
You can use Bollinger bands to filter the trends that you find. With this strategy, when the market is in an uptrend close to the upper range of the Bollinger bands, you should let the trend go. When the market is in an uptrend in the lower range of the Bollinger bands, however, you know that the market has enough room to move upwards and that you have found a trend that has the potential to continue for a while. This would be a good opportunity to invest.
With this type of strategy, you should be able to win a higher percentage of your trades than with a strategy that focuses on following trends alone.
To improve your winning percentage further, you could use the relative strength index (RSI). The RSI puts past upwards movements in relation to past downwards movements and plots this relationship in a line with a value between 0 and 100.
- Values over 70 are considered overbought, and
- Values below 30 are considered oversold.
- Some risk-averse traders increase the limits to 80 for overbought markets and 20 for oversold markets.
In overbought and oversold environments, a reversal is likely.
- When the RSI has a value of over 70, the market is likely to turn downwards soon.
- When the RSI has a value of below 30, the market is likely to turn upwards soon.
You can use the RSI to add another filter to your strategy. Now, your strategy would look something like this:
- You trade uptrends when the market is trading in the lower range of the Bollinger bands, and the RSI is in the oversold area or just came out of it since the uptrend started.
- You trade downtrends when the market is trading in the upper range of the Bollinger bands, and the RSI is in the overbought area or just came out of it since the downtrend started.
With this strategy, you should be able to win a very high percentage of your trades. Of course, since you filter out some signals, you will find fewer trading opportunities. You can make up for this disadvantage by investing a higher percentage of your overall capital.
- When you combine Bollinger bands and the RSI to filter signals, you can invest 5 percent of your overall money in a trade.
- With a strategy that trades Bollinger bands alone, you should limit your investment to 3 to 4 percent, and
- When you trade trends without any additional indicator, you should never invest more than 2 percent of your money in a trade.
In this way, Bollinger bands can help you to improve your trading results while still allowing for high profits.
Example 2: Using Bollinger bands to create trading signals directly
In a somewhat simpler strategy, you can trade Bollinger bands directly. Most traders do this by focusing on the moving average in the middle of the Bollinger bands.
- When the market crosses this moving average from the lower side of the Bollinger bands to the upper side, they invest in rising prices.
- When the market crosses this moving average from the upper side of the Bollinger bands to the lower side, they invest in falling prices.
The simple logic behind this kind of strategy is that the market must have turned around when it changes from one side of the Bollinger bands to the other. Consequently, this crossover signals a good time to invest.
Of course, this simple strategy requires a lower investment per trade, ideally around 2 to 3 percent.
Example 3: Using Bollinger Bands to filter candlestick formations
Candlestick formations are a great tool to predict future market movements because they are easy to learn but still allow for sophisticated predictions.
Candlesticks are a special way of displaying market movements. Every candlestick aggregates the market information of an adjustable period of time into one candlestick, displaying the opening price and the closing price with its thick body and the periods high and low with thin wicks to each side. With this simple system, you can understand a period’s full price range with one view.
Some candlesticks allow for easy predictions about what will happen next. A candlestick with a small body but a long wick to either side, for example, indicates that the market moved far from the period’s opening price, only to return again. This movement is likely to continue, which is why you should invest into the opposite direction of the wick.
Similarly to what we did with trends, Bollinger bands can help you to filter candlesticks. In its simplest form, such a strategy could look something like this:
- You only invest in candlesticks that predict rising prices when the market is trading in the lower range of the Bollinger bands. This way, you know that there is enough room for the market to rise after the candlestick. When the market is close to the upper line of the Bollinger bands, you do not invest in candlesticks that predict rising prices because there is too little room for the market to develop a significant movement.
- You only invest in candlesticks that predict falling prices when the market is trading in the upper range of the Bollinger bands. This way, you know that there is enough room for the market to fall after the candlestick. When the market is close to the lower line of the Bollinger bands, you do not invest in candlesticks that predict falling prices because there is too little room for the market to develop a significant movement.
This strategy keeps things simple, but it is easy to implement, even for complete newcomers. Of course, you will filter out a few signals that would have led to winning trades, too, but the number of losing trades that you filter out will be much higher, and your overall winning percentage should increase significantly.
Consequently, you can risk investing more per trade than with a pure candlestick strategy. With the Bollinger bands, you can invest around 4 percent of your overall capital per trade, without them, you should keep your investment to 2 percent.
Adding Bollinger bands to your candlestick strategy can increase the security of your strategy and your overall profit.
Bollinger bands are a great indicator to understand whether the market is currently trading high or low. With this information, you can trade a number of strategies for binary options that combine simplicity with profitability. Even newcomers can use Bollinger bands to find a simple way to make their first predictions.
From here, we also recommend our article on Pivot Points