Bollinger Bands for Forex Trading: A Beginner’s Guide
In forex trading, Bollinger Bands is a technical analysis tool used by traders and investors to understand market volatility.
John Bollinger, a technical chartist/trader of Financial News Network developed the Bollinger Bands in the mid-80s.
Bollinger Bands in a Graph
Bollinger Bands is an envelope in the form of two lines: one above and one below, which surrounds the price bars on a chart.
In the chart above, the blue line in the envelope is the upper Bollinger band and the red line in the envelope is the lower Bollinger band. The black line is the median line.
Two standard deviations away from a simple moving average define how Bollinger bands are plotted.
The gaps between the bands from the moving average lines represent market volatility.
The band grows wider from the moving average lines during volatile market periods and narrower during less volatile periods.
Bollinger Bands Formula
Upper Bollinger Band = N Day Simple Moving Average (Normally 20 Day SMA) + 2*Standard Deviation of prices
Lower Bollinger Band = N Day Simple Moving Average (Normally 20 Day SMA) – 2*Standard Deviation of prices
The use of Bollinger Bands
Bollinger Bands can tell you when the market sentiment is about to change.
Using a trading strategy based on the Bollinger Bands, traders can predict when an asset price is about to enter the overbought or oversold territory.
They show an overbought or an oversold market by using the upper and lower bands.
So, when the price of the asset is at the upper band, we say the market is overbought and when the price of the asset is at the lower band, it is an oversold market.
This means asset prices are relatively high at the upper Bollinger Bands and relatively low at the lower Bollinger Bands.
What is Bollinger Squeeze?
The term “Bollinger Squeeze” happens when the bands squeeze together. This often explains that a breakout is about to take place.
If the chart candlesticks begin to break out above the top band, then the move will normally proceed to go upwards.
If the chart candlesticks start to break out under the bottom band, then the price will usually progress to go downwards.
Bollinger Bands and another indicator
Bollinger Bands do not generate buy or sell signals on their own reliably. You can use them with other indicators, such as the Relative Strength Index (RSI) or other chart patterns.
When prices hit one of the bands, it can signal a continuation or reversal of the trend. RSI is a superb indicator with respect to overbought or oversold conditions.
When prices touch the upper Bollinger bands and the RSI is below 70, it is an indication that the trend will continue.
However, if the price meets the upper Bollinger bands and the RSI is above 70 and possibly approaching 80, the trend may reverse and decline.
Short, medium and long term trading
2 standard deviations from the simple moving average plot Bollinger Bands. For short term trading, a moving average of 10 days is more suitable.
For the medium-term trend, a simple moving average of 20 days and for long term trades, a simple moving average of 50 days would be more appropriate to ride the long term trend.
Forex traders should adjust the period of the bands depending on the tenure of their trading strategies.
Technical indicators are very powerful but they have to be used in the proper context without which the utility of the indicator diminishes.
While trading or investing, it is essential to keep the big picture in mind, indicators like Bollinger Bands and RSI play a vital role in understanding that overall picture.
To find out more about Bollinger Bands and forex trading, contact us at Tradehall and sign up for our Starters Package today.