One common feature is similar for any chart and any asset class in the financial markets - prices always move like waves. Binary options type of trading is keen on taking advantage of that attribute of quotes behaviour. Any strong trend comes together with healthy retracements from time to time with rates of underlying assets coming back to average values, while bullish or bearish accelerations are accompanied by higher volatility. Bollinger Bands binary options Strategy became popular thanks to the simple view and clear indication of those three basic factors for the price action - average value, volatility and fluctuations range.
What Is a Bollinger Band?
John Bollinger, a technical analyst, noticed a need for enlarging the scope of a usual moving average as it indicates the trend’s direction but does not show how fast and how far stock prices move from their true value. As a result, he invented a technical indicator, which is based on an exponential moving average but has three lines instead of one. He used a deviation, a parameter based on mathematical formula measuring the dispersion of close prices for a chosen period relative to its mean. By a simple act of adding or subtracting the deviation, the Bollinger Bands indicator calculates ranges for upper and lower price channels above and below the moving average. What’s more, the deviation formula measures the underlying asset’s volatility in binary options.
What do Bollinger bands show?
- The middle line points to the average value of the underlying asset. This is a standard exponential moving average with the chosen period;
- The upper line shows the current resistance. This is a dynamic curve, the value of which depends on recent price action and volatility. When quotes are placed between the middle and upper line, the binary options market is in the uptrend;
- The lower line indicates the support level. It also changes the value if prices move fast. Downtrend conditions occur when rates are between the middle and lower lines.
The screenshot below shows the structure of Bollinger Bands explained:
Bollinger Bands settings
The indicator has two main parameters influencing the overall view:
- The first one is the period or length, which affects the middle moving average. The larger period is set, the wider Bollinger Bands’ range is shown. The default period is 20 bars. Choosing the right period depends on individual binary options strategy, the preferred expiration time for binary options and the selection of an underlying asset. The most common Bollinger Bands Binary Options strategy suggests using period like 21 or 34 bars.
- The second parameter is a deviation . Usually, binary options choose deviation 2, while a smaller value would squeeze the indicator’s vertical range, and a higher value spreads the amplitude. There is also a Double Bollinger Binary Options trading strategy, implementing two indicators with different deviations.
Here is where settings can be changed:
How to read Bollinger Bands?
Reading Bollinger Bands stock charts is simple as the indicator reflects the price action and change in the momentum.
There is a general set of rules describing several events in the binary options market:
- During a strong uptrend or downtrend, Bollinger Bands lines spread the overall range between them, and head in different directions. That is a strong signal about larger volatility, and chances for a bullish or bearish acceleration grow, depending on the trend direction.
- If Bollinger Bands lines narrow the overall range after a strong trend, then a retracement or correction is likely, and the price might bounce back to the average value, as the volatility drops.When a price crosses the middle line, that usually points to a change of the current sentiment.
- If the crossover was charted from below to above, then the bearish bias would change to the bullish one.
- If a daily (weekly, hourly) close price (not a shadow of the candlestick) appeared above the upper line or below the lower line, then a bullish or bearish breakthrough might happen, predicting higher or lower prices to be charted in the nearest future.
- If a test of the resistance/support happened, and an asset charted a whipsaw above/below the line but failed to breach it with the close price, then a rebound to the middle line is likely.
Here is an example of bollinger bands stock chart in action:
How to use Bollinger Bands?
Like any other system based on the technical analysis, Bollinger Bands aims to find reversal conditions, calculate the average value, as well as determine resistance and support levels. Given the mathematical formula based on calculating channels, the indicator has the most effective performance during sideways consolidation ranges as it clearly shows the market’s intentions from the previous action. At the same time, the start of a strong trend is also visible when Bollinger Bands lines spread the overall range, pointing to larger volatility. Thus, binary options traders can take advantage of the Bollinger Bands indicator to maximise the profit when prices chart a one-way performance.
Therefore, before trading with Bollinger indicator, traders should make several preliminary conclusions:
- Find out whether the underlying asset is in an uptrend, downtrend or consolidation on larger timeframes than the chosen expiration time;
- Determine whether a reversal or by-trend trading strategy is preferable;
- Decide whether to buy call/put options is more attractive or the two-way strategy is desirable.
After, that traders can use the rules described above. For example, buy call options after the price crosses the middle line, targeting the upper band as the level when to stop the trading cycle. Or enter against the bullish trend, buying put options when rates failed to break through the upper line.
If you like this strategy, you might also be interested in this Trend line Trading Strategy
Examples of profitable trades
Intraday two-way trading on currency cross-rates in both directions
The screenshot below shows how effective the binary options strategy is when the underlying asset is in a sideways range, even though with a slightly bullish bias. Several entries were used on reversal signals, while the number of profitable deals clearly overweights corrective candlesticks during all of the three intraday trading cycles shown on the chart.
Combination with Bollinger Bands and ADX Indicator
Several additional technical tools might be added to the technical analysis in order to compensate Bollinger Bands weak points and filter false signals. One of the most effective tools for such a combination is the ADX indicator, which shows the markets momentum. If the ADX mainline edges higher, and the ADX surplus is negative (red), while prices reach the bottom range of the Bollinger Bands, then the likelihood of bearish continuation is high. However, if the rate failed to chart a bearish breakout, then it’s worth waiting for a retracement to the middle line before continuing buying call options. Here is the GBP/USD daily chart setup to use Bollinger Bands together with ADX indicator.
Pros and Cons
Despite the indicator’s informative view compared to standard moving average, and effective trading signals with simple rules and clear conditions, the Bollinger Bands binary options strategy, like any other lagging indicator might show false signals, especially when the binary options market is affected by large volatility and sharp price swings. That is mostly related to breakthrough signals, which do not guarantee further movements in the same direction.
- Simple view;
- Informative data representation;
- Flexibility of settings;
- Effective signals;
- Indication of volatility.
- Lagging nature;
- False breakout signals.