Bollinger Bands Explained: How to Use Them in Trading

How to Use Bollinger Bands in Trading 

Hello everyone.  In today’s topic, we will learn how to use Bollinger Bands in your trading journey. Now, when we talk about Bollinger Bands, what exactly are they? 

Bollinger Bands are essentially a range through which we expect the market to move. This is based on a mathematical calculation. I will try to show you how this calculation works on the screen, but let me first explain the basic concept.  Bollinger Bands take a 20-period moving average as the centre line. Around this centre line, we generally apply two standard deviations. The standard deviation can also be adjusted depending on the requirement and the instrument being analysed. I will explain that in the later part of the video.  For now, we will use two standard deviations. Using two standard deviations essentially helps us understand how far the market may potentially move away from the central moving-average line. Now, how do we use this practically? 

Let us understand it on the chart. 

Applying Bollinger Bands on the Chart 

If we look at the chart, you can see that this is an actual running market chart. 

Notice how the market is moving within a range. At different points, the price keeps moving within a defined zone. Now, let us apply the indicator. We go to the indicators section and select Bollinger Bands. As soon as Bollinger Bands are applied, you can see a shaded area around the price. This shaded area represents the range within which the market is moving.  Now, if we go into the Bollinger Band settings, you will notice that the length is set to 20. This means the centre line is technically a 20-period moving average. The multiplier is set to two, which means we are using two standard deviations. If I change the multiplier from two to three, you will notice that the range becomes wider. Therefore, instead of changing the default settings unnecessarily, we will generally discuss Bollinger Bands using the standard 20-period moving average and two standard deviations.  However, when we are analysing a more volatile instrument, the settings can be adjusted. For example, if we are analysing Bank Nifty, which is generally more volatile than Nifty, we may use a standard deviation of 2.5 or even three so that the bands can accommodate the wider price range. 

Understanding the Upper and Lower Bands 

Now, let us understand what is happening on the chart. Suppose the market opens and the price is trading close to the 20-period moving average. 

You can notice that when the price moves lower, it reaches the lower end of the Bollinger Band. It tests the lower band and then moves back upwards. On the upside, the price moves above the 20-period moving average, but eventually reaches a hurdle.   That hurdle is the upper Bollinger Band. This is an important concept. The upper band can act as the upper end of the current price range, while the lower band represents the lower end of the range. Now, notice another situation.  Suppose a large spike candle appears. The price moves sharply, but the Bollinger Band range expands only slightly.  The range has not expanded significantly. This means that although the market has moved outside the earlier range temporarily, the bands are not yet confirming a major expansion beyond that range. If the next candle turns red and the market moves back inside the Bollinger Bands, it tells us that the earlier move did not receive enough follow-through. 

Using Bollinger Bands for Profit Booking 

When the market starts repeatedly reaching the upper end of the Bollinger Band, it can be an indication that traders should start thinking about profit booking.  However, this does not mean that you should immediately exit the moment the price touches the upper band. You should observe what the next candle is doing.  For example, suppose a strong green candle forms near the upper band. If the next candle is also a strong green candle, the move may continue and the Bollinger Band itself may start expanding further.  In that situation, you may continue holding the position. However, if the market is rising and the next candle fails to continue the green candle formation and instead starts turning red, that can become an important signal.  You may not even need to wait for the entire candle to close to understand that momentum is weakening. If the market was going to continue higher strongly, price would generally start trading above the previous candle.  But if the market is unable to cross the high of the previous candle and the next candle is unable to continue the upward move, it indicates that momentum is weakening. At that point, the market is giving you a signal that you may consider booking profits. You may enter the trade again later if another opportunity develops, but at that moment, the chart is indicating that the current move may be losing strength. 

Using the Lower Band for Short Positions 

Now, let us look at the same concept on the downside. Suppose price starts falling and moves back towards the 20-period moving average. It then continues lower and reaches the lower Bollinger Band.  A red candle hits the lower end of the band. If the next candle is also red, the downside trend may still be continuing. However, if the following candle turns green, it indicates that downside momentum may be weakening. If you were holding a short position, this could be a point where you consider booking out.  This is important because if you fail to book profits when the momentum reverses, your stop-loss requirement may become significantly larger. After the green reversal candle, the market may start moving upwards again.  It can continue rising until it reaches the upper Bollinger Band. Once again, the upper band becomes a hurdle and the market may pause there. This demonstrates a very important characteristic of Bollinger Bands. The market often attempts to move within a range defined by the bands. 

Understanding Range Expansion 

Now, let us look at another example.  Suppose the market opens outside the Bollinger Band range but immediately falls back inside the range. The market may open higher, outside the upper band, but then quickly move back inside the band and start moving lower.  After that, it may again become sideways and settle within a range. This shows that simply opening outside the Bollinger Bands does not automatically mean that a new trend has started.  You need to look at follow-through. Now consider another situation where price repeatedly hits the upper band and continues moving higher. If the market keeps hitting the upper band and the band itself starts expanding, this indicates range expansion.  The important signal here is repeated follow-through. The market reaches the upper band, another candle follows in the same direction, and the Bollinger Band starts widening.   As long as the follow-through continues and the upper band keeps expanding, the market may continue trending higher. However, if the band is still expanded but the price stops reaching the upper band, it can indicate that the market is starting to pause. That can become another indication to review the position and consider profit booking. 

Using Bollinger Bands as a Trend-Following Tool 

If you apply this simple indicator while following trends, Bollinger Bands can provide useful signals regarding where the upper and lower ends of the current market range are located.  Suppose you are in a long position and the market reaches the upper end of the Bollinger Band. You may consider booking out. However, booking out of a long position does not mean that you must immediately enter a short position.  For a short position, you should look for additional confirmation. For example, if the market moves below the 20-period moving average, it may then attempt to test the lower Bollinger Band.  If price moves below the middle line and then repeatedly hits the lower band, that can indicate continuing downside momentum. In this way, the 20-period moving average can be treated as a baseline. You can observe how the market behaves above and below this baseline. As long as the market continues to hit either the upper or lower Bollinger Band with follow-through, you may continue tracking the existing trend. 

Conclusion 

Bollinger Bands are one of the simplest indicators that can provide guidance about the current market range and direction.The middle line acts as a baseline, while the upper and lower bands help identify the probable extremes of the current price range.  Repeated interaction with the upper or lower band, along with expansion of the bands, can help traders understand whether momentum is continuing. At the same time, failure to continue hitting the bands can indicate that the market may be starting to pause or reverse.  Bollinger Bands are one of the most commonly used indicators because they provide a visual representation of the market’s trading range and can help traders understand market direction more clearly. 

We will meet again in the next chapter and learn something new. 

Disclaimer: Investments in securities markets are subject to market risks. Read all the related documents carefully before investing.