The Bollinger bands indicator in trading: pros and cons

When planning a trading deal for the selected instrument, each trader, first of all, tries to determine the trend direction, strength, and volatility of the instrument, as well as the location of potential strong support and resistance levels.

A successful trader with a lot of experience can determine these points just by looking at a chart, but following the proverb: "Measure twice, cut once", a professional trader would prefer to use instruments of technical analysis to confirm his guesses or beliefs. Without confirmation of their forecasts every trader, especially beginners, risks being mistaken in their forecasts and open knowingly losing deals.

And to significantly reduce the percentage of such losing trades, traders use one of the technical analysis indicators, called Bollinger Bands, which will be discussed below.

What is the Bollinger Bands indicator?

Bollinger Bands indicator was invented by American technical analyst, trader, and founder of the corporation "Bollinger Capital Management" John Bollinger in 1983. Nevertheless, this indicator is still relevant today. Like many other technical analysis tools, Bollinger Bands were developed primarily for the stock market, ie for share trading, but traders of the foreign exchange market have been able to successfully apply the indicator to the currency pairs Forex.

When constructing Bollinger Bands a simple moving average with the most popular period of 20 days and two standard deviations of this simple moving average in the form of two bands are used - above the MA and under the MA. The number of standard deviations determines the distance between the average and upper and lower bands.

On the whole, the Bollinger Bands indicator can be called a universal indicator, as it helps to determine the overbought or oversold condition of the instrument being traded, as well as support or resistance levels. Moreover, when the bands widen, it means that volatility increases, and when they contract, it means that the price of the instrument decreases and falls into a "sideways slump". The narrowing of the bands, which is also called "squeezing", may also signal the probable end of a "sidewall" after a certain period of consolidation in the range and continuation or reversal of the trend.

Of course, if the price reaches the upper band which may signal the instrument is overbought it does not necessarily mean we should sell from this band, and if it goes down to the lower one it does not necessarily mean we should buy. Nevertheless, Bollinger Bands are traditionally used for such situations, but it is more effective to use the price decrease to the lower band in an ascending trend for buying from support and, consequently, the growth to the upper band in a descending trend - for selling. In other words, with the help of Bollinger Bands, it is convenient to open a position on a pullback and become on the trend. And, of course, reaching the upper or lower boundary of the price can be used not only to open a new position but also to close an existing one.

It should be noted here that the indicator itself is not an autonomous trading system as such. To improve the efficiency of trading with its use, it is better to apply other tools of technical analysis, which we will talk about below.

Pros

• Considering the above, the advantage of using the Bollinger Bands is that this indicator makes it possible to predict the potential tops when the instrument's price is rising and the potential bottoms when it is falling. When the instrument price and volatility are rising and the bands are sharply directed upward, reaching the upper band may signal that the price has reached a maximum from which a pullback or trend reversal is possible.
  
• Likewise, when the price reaches the bottom band which is sharply directed downwards when the downtrend is developing and volatility is increasing, it can signal that the price has reached the "bottom" from which either a pullback or a trend reversal is possible.
  
  
• Another plus is that this indicator clearly shows the growth or decline in volatility, as well as the strength of the current trend. The more the bands widen, the stronger the trend and the higher the volatility, and vice versa, the more the bands contract, the weaker the current trend and the lower the volatility.
  
  
• Another advantage is the ability to mark the consolidation range boundaries when the volatility drops and the instrument price enters a "sideways trend". If the price enters a consolidation phase within a long-term trend, a trader can use the upper and lower Bollinger bands for range trading or trading on a level breakout.

Cons

• The disadvantages of the Bollinger Bands indicator, of course, can include the fact that its use as a stand-alone trading system in most cases is not effective, or ineffective. Quite often situations happen when the price confidently breaks through the upper or lower Bollinger Band and moves much higher (or lower) than the broken band. In this case, the trader who opened a position from it is in an extremely unenviable position and is forced to either hold the position hoping for a rollback to the broken band, which at the time of the rollback may be much higher or lower than the entry point, or his position will be closed with a protective stop-loss order placed above the band.
  
• In the first case, the trader will incur unpredictable losses, and in the second - will incur losses on the stop loss, which, of course, also cannot support his morale. And how to continue working with low morale? There is no way... It is possible, of course, to think of a bar on the nearest street, but in case of frequent failures in trading, it can lead to other problems, and the trader will have no chance to correct mistakes and recoup losses incurred.
  
  
• Another disadvantage of Bollinger Bands is their lagging at the beginning of a trend or its continuation. Until the bands will turn in the direction of the trend and begin to expand, the instrument's price chart can already pass some distance, and if the trader can not recognize the emergence or reversal of a trend, he simply will miss it and lose the profit. Then the story with low morale will repeat itself because for many traders the missed profit is no better than a loss incurred. The longer the trend is, the bigger the lag will be. In a short-term trend, there will be more false signals - after expanding, for example, upward, the trend may reverse and the bands will expand downward, and vice versa and the trader will simply get lost in all these expansions and will not be able to make the only correct trading decision.

The Bollinger Bands lag is primarily due to the fact that they react to the price chart movement rather than predict it. Thus, this indicator belongs to the lagging indicators of technical analysis, which, of course, is a big minus.

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