Using Bollinger Bands in Binary Options
What is a Bollinger Band?
The Bollinger band indicator was developed in the 1980s by John Bollinger (BollingerBands.com). Three bands make up this Bollinger indicator:
a) The upper band which serves as a resistance band in range-bound markets.
b) The middle band which has a neutral bias in the sense that it can function as a resistance for price action coming from the lower band, or as a support for prices coming from the upper band.
c) The lower Bollinger band which serves as a support band, especially in range-bound markets.
Bollinger bands have a horizontal orientation at areas where the market is in consolidation. When the price movements are very minimal, they tend to contract into tight bands known as the squeeze. When the market experiences a breakout, they also break into wide bands.
In terms of trading binary options, the best way to use Bollinger bands in a manner that will not create an ambiguous situation for the trader is to use them in range bound markets to determine clear-cut areas where a price bounce (at the upper Bollinger) or price retreat (at the upper Bollinger) occur.
For this to happen, the trader has to apply the Bollinger band to a range bound market, and add an indicator that shows when the market is overbought or oversold (such as the Stochastics oscillator). With the help of the Stochastics oscillator, it is then easy to take a bullish position at the lower Bollinger when the market is oversold, or assume a bearish position when the market is overbought at the upper Bollinger band. You can read more about this in our 60s binary options strategy lesson.
Trading System using Bollinger Bands:
One system that can be used to trade this system is the Basic Bollinger system, which utilizes the Bollinger band, the Stochastics oscillator and the automatic pivot point calculator. Using this system which was initially developed for the forex market, the trader can trade as follows:
Call Option (read about the Call/Put Option here)
– Stochastics set at 10,3,3 is oversold (<25)
– Price is at lower Bollinger band
– Price is close to a support level on pivot point
– Stochastics set at 10,3,3 is overbought (>75)
– Price is at upper Bollinger band
– Price is close to a resistance level on pivot point
The expiry for the trade must be set using the time frame chart as a guide. For instance, when using a one hour chart for the trade analysis, it is expected that the asset should be able to perform according to expectation in about 3 hours. When using a daily chart, the asset should be able to perform in 2 to 5 days. Eventually, the exact expiry time to be used will depend on the experience the trader has garnered from using a demo platform.
There are other ways that the Bollinger band can be used. One of them is to use what is known as the Bollinger squeeze. The Bollinger squeeze is formed when price is so contracted that the length of the candles is thin, showing a breakout potential. The trader can then use price targets above and below the squeeze for a potential boundary trade. It is better to use the OUT option in this case, as the OUT option is a binary options outcome that does not have a bias (either a breach of the upper limit or lower limit will put the option in profit). Since it is not certain to which direction the asset will break out to, but it is certain that a breakout will occur, the trader can apply two trend lines above and below the squeeze. The most recent price highs and lows should be used as a guide, and the trend lines applied below the high and above the low. This will ensure that a breakout that aims for these key levels will trigger one of the two upper limits before anything else occurs.
These are the two surest ways to use Bollinger bands to trade binary options, and they must be used after some experience has been gained with them on demo.