In this post we go through how you can set them up on your charts and three easy strategies you can use to trade with them. The common standard setting is to have the middle band set to a 20 period simple moving average. The upper band is created by taking the middle band and adding twice the standard deviation.
The lower band is created by taking the middle band minus twice the standard deviation. Middle band: Created with 20 period simple moving average.
Upper band: Created from middle band plus two standard deviations. Lower band: Created from middle band minus two standard deviations. One of the most common Bollinger Band strategies is using them to gauge if a market is overbought or oversold. A lot of traders will use these bands and look for price to revert back the middle band or to the mean.
When using a mean reversion strategy we are assuming that if price deviates or moves too far away from the mean it will eventually have to come back. This is often looked at as price moving back from an overbought or oversold market into more true value. As the chart shows below; price tags the upper band before rotating back lower. It also moves lower before tagging the lower band and moving back higher.
This strategy can work well in ranging and sideways conditions. However, if price goes on a long trending run, then we can see long periods where price does not move back to the mean and middle band. This is where using Bollinger Bands in trending markets can be used. In strong trending markets where the move has a lot of momentum price will spend a lot of time away from the mean.
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