Do you know this fact that the Bollinger Bands can be used as a very effective tool for detecting and trading trends even though most of us have only be taught to use them in a range bound market. Here is how to capture the trend with Bollinger Bands (BBs). Bollinger bands are used to measure the deviation or what we call volatility in the market. Bollinger bands measure the standard deviation of price action away from its 20 period moving average.
Now, if we superimpose a second set of BBs with standard settings of 1 standard deviation on to a price chart that already has a BB with the default settings of 2, you will be surprised to find out as the price action tends to start trending in the market, it will be contained in the 1SD-2SD BBs.
These BB bands divide the price action into three separate zones. If prices are between the upper 1 SD BB and the upper 2 SD BB, they are in the buy zone. If the price action is between the lower 1 SD BB and the 2 SD BB, it is in the sell zone. The area between the second Bollinger Band Bands is known as the no man’s land as the price action is struggling to find direction here.
So if the prices trade between the two upper BBs, it is an uptrend. If the prices trade between the two lower BBs, it is a downtrend. If price action is between the two upper and the two lower BBs, it is trendless without any direction. When price action closes in the buy zone, it is in an uptrend. So when to enter into a long trade?
Here are the rules for making a long entry. Price action must enter the BB buy zone. The price should close within the buy zone to enter into a long trade. Enter into a long trade at the close of the entry bar. Place the stop loss at the bottom of the entry bar. If the trade moves in the right direction, exit only when prices close below the buy zone.
Similarly, the rules for making a short trade are: price action must enter the BB sell zone. The price action should close within the sell zone for you to enter into a short trade. Enter into a short trade at the bottom of the entry bar. Place the stop loss at the top of the entry bar. If the trade moves in the right direction, exit only when price action closes above the sell zone.