Use of Bollinger Bands in Mean reversion

When prices move too far and too fast, the market usually pulls back towards prices considered more normal, which may be around a moving average. This is called a mean reversion.

For example, the gap between the current price and the 55-day moving average is the widest since December. This could be a warning sign that prices and the 55-day moving average may converge soon.

To some extent, it is possible to obtain more reliable signals using tools such as Bollinger Bands. Bollinger Bands are used to reflect the volatility of a particular security or currency pair. Explaining Bollinger Bands and their detailed strategy applications is complex in itself, so here we will briefly introduce some of the more important foreign exchange knowledge for you.

Bollinger bands are formed around a simple moving average, with the top and bottom of the range located on either side of the moving average. The top of the range (or the upper track) is two standard deviations above the moving average, and the bottom of the range (or the lower track) is two standard deviations below the moving average. The charm of Bollinger Bands is that the width of the Bollinger Bands is automatically adjusted according to the price fluctuation, calculated according to the standard deviation formula.

Of the normally distributed data columns, 68.2% were within one standard deviation of the mean, 95.4% were within two standard deviations of the mean, and 99.7% were within three standard deviations of the mean.

A rise above the Bollinger Band or a fall below the Bollinger Band means that the price trend is very strong and likely to continue in that direction - subject to confirmation, of course.

However, if the price movement outside the Bollinger Band is accompanied by a clear reversal signal from other instruments or indicators, the reversal signal will be more effective than usual. Bollinger elaborated on this concept at the 2001 Tokyo International Union of Technical Analysts conference. He used an umbrella line as an example to show that if such a reversal candle line appeared on or outside the Bollinger Band, it would greatly improve the reliability of the candle reversal pattern.

John Bollinger has created several byproduct indicators of Bollinger Bands that bear his name. One of them is "% b". It is very similar to the algorithm of stochastic indicators, hence the name. In short,% b is an indicator that shows how prices behave when associated with Bollinger Bands.

When the price moves outside the Bollinger Bands, the value of the% b indicator will reach 0 or 1, and then it will deviate from the price, indicating that the price may soon reverse. Of course, we must not forget that in practice, we need to refer to other indicators to confirm this.

Once you learn to use the Dayi tool, it can be a powerful early warning signal of a trend, forming a strategy to catch a trend reversal and a possible return to the mean. Some use it to open new positions, while others use it as a warning signal to exit the trade.

If you open a trade with% b, keep in mind that you are trading against the trend at first. You are trying to pounce on a clearly falling trade (if you buy). If you deal well, you can make a profit quite quickly. However, if you deal poorly and the price continues to move downward, then you need to think carefully about whether to increase your position.