Binary Options traders are often found using Bollinger Bands to trade in options market. Bollinger Bands indicator is a highly lauded technical indicator and can be used with a range of different binary options types such as Digital Options, Touch, Range etc. The reason why this technical indicator has earned popularity is its ability to identify quality entry points that can lead to profitable trades.
What are Bollinger Bands?
Bollinger Bands took birth in 1980s with John Bollinger as their creator. During those days it was believed that market volatility was static by nature and not dynamic. In order to prove that the volatility was dynamic, he needed adaptable bands and hence came up with the concept of Bollinger Bands.
What Really Do the Bollinger Bands Do?
Bollinger Bands help traders to find the interrelation between high and low prices of an underlying asset for a given time frame. The upper band is designed to register high figures while the lower band is designed to register the low figures.
How Effective are Bollinger Bands?
Bollinger Bands are pretty effective because they allow price movement comparison and when used in conjunction with other technical indicators that generate alerts, these bands can provide excellent entry and exit point information.
A Quick Look at Bollinger Bands:
In the figure below, you will see three black lines. These three lines together form Bollinger Bands. The one in the middle is nothing but a simple moving average and is generally used as a foundation for the upper and lower bands.
The greater the distance between the upper band and the lower band, the greater is the market volatility. Higher volatility implies that the upper band and the lower band will diverge while lower volatility implies that the two bands will converge.
A few things to notice:
- It is easier to trade the fluctuations around the central band or the simple moving average band.
- The upper band works as a resistance level.
- The lower band works as a support level.
Do You Need to Calculate Anything?
Of course the Bollinger bands are derived from mathematical calculations but most chart providers will do this calculation for you. All you have to do is to select a time frame and apply. You will immediately see the Bollinger Bands popping up on the chart.
What Kind of Time Frame Do You Need to Use?
In order to get the answer to this question, you need to answer another question. What type of trades to you like – short term or long term? Bollinger Bands are generally calculated for a 20-day time frame but they can be easily applied for trades as small as 60 seconds. However, the longer the time frame you select, the better are the results because of greater statistical accuracy. The chart that you see above is based on 5-min time frame.
What Type of Binary Option Trading Suits Best With Bollinger Bands?
We answered this before. You can actually trade any type of binary option using Bollinger Bands. You may just have to use other technical indicators. However, Bollinger Bands in binary option work best with Range Trading. Take a look at the chart above. On the right side you will see that the upper band and the lower band are running almost parallel to the central band. This is when the market is stable and the price is ranging. On the other side (i.e. left) you will see sharp fluctuations. The upper band and the lower bands keep diverging and converging reflecting extreme noise in market. In other words, sometimes the bulls take control and sometime the bears take control.
How to Trade Binary Options Using Bollinger Bands?
We said that upper band shows resistance and lower band shows support. Generally, the prices must stay within the upper band and the lower band. If however, the prices touch any of the two bands, sharp retraction is expected. So, if the prices touch the upper band, you need to open a Put option and if the prices touch the lower band, you need to open a call option. Take a look at the following image below. The Bollinger Bands are represented by the blue lines. Points for activating CALL and PUT options are shown for using arrows.
NOTE: For 95% of the times of the selected time frame, price of the underlying asset in Binary Options will range between the upper and lower Bollinger Bands. Sometimes the price with touch and rebound from the upper band (resistance) and sometimes do the same with lower band (support).
What about breakouts?
It is possible for the asset price to break the support or the resistance and create a new trend. How do you identify that with Bollinger Bands? This isn’t difficult at all! You will need what is known as a Break Line. You need to draw this. Here are the steps you need to follow:
- Open a chart. The example shown below is EUR/USD.
- Activate Bollinger Bands (shown by blue lines in the image below).
- Identify two prominent high prices (resistance points) and two prominent low prices (support points).
- Connect these points using a straight line. The line joining the resistance points will be the Bull Break Line and the points joining the support points will be the Bear Break Line.
- Now wait for the middle Bollinger Band to cross any of these two Break Lines. The moment the central band breaks through one of these Break Lines, it will indicate a price breakout. In our example below, you can see a bearish breakout because the central blue band crosses the Bear Break Line and moves below.
- Look for another confirmation. See whether the candlestick is forming above or below the Break Lines. In our case the candlestick is formed below the Bear Break Line. This will confirm the breakout.
- The moment you confirm a Bull breakout, go for a CALL option and in case of a Bear breakout, go for a PUT option.
Remember: Breakouts are short term by nature and the market will have a tendency to correct the prices shortly after the breakouts. So, if you want to work with breakouts, make sure that you implement Bollinger Bands for shorter time frames like 60 seconds or 5 minutes or 15 minutes.