How Forex Traders Use Bollinger Bands

Bollinger Bands are Forex trading indicators that were first developed by John Bollinger during the 1980s. Bollinger Bands are a pair of values placed as an "envelope" around a data field. The bands are useful for determining whether current values of a data field are behaving normally or breaking out in a new direction. This indicator is designed to capture the majority of price movement. Bollinger Bands are a kind of trading envelope. Bollinger Bands are similar to moving average envelopes.

Price

When the two bands are far apart, prices are more volatile and will tend to fluctuate between the two bands. Traders generally use them to determine overbought and oversold zones, to confirm divergences between prices and indicators, and to project price targets. As a rule, prices are considered overbought when they touch the upper band. When prices move beyond the upper or lower band, they are considered high (overbought) or low (oversold) on a relative basis.

Trend

The Bollinger bands allow you to foresee sharp price changes, trends, reversal of trends and can also be used to make price projections. The narrowing of the bands often indicates the start of a new trend, which is confirmed when prices break and close out of the band. When Highs and Lows occur outside of the bands and these highs and lows are followed by highs and lows inside the bands, it tends indicate a reversal of the current trend. If the bands are close and then begin to widen, it may signify that the trend is weakening and may possibly be due for a reversal.

Volatility

The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. The Bollinger Bands indicator’s main function is to measure volatility. When volatility is high the Bands widen. When volatility is low the Bands shrink. A narrow envelope indicates a lower amount of volatility while a wide envelope indicates a higher amount. High volatility levels can sometimes be used to time trend reversals, such as market tops and bottoms and low volatility levels are sometimes used to time the beginning of new upward price trends following periods of consolidation.

Periods

The default setting for Bollinger bands is 20 and 2, which means the indicator takes the past 20 time periods into account and bases its calculations based on two standard deviations from the mean. Bollinger recommends using 20 for the number of periods in the moving average and using 2 standard deviations. Using the standard deviation ensures that the bands will react quickly to price movements and reflect periods of high and low volatility. Commonly used periods are twenty, thirty, fifty, hundred and two hundred days.

In conclusion, let's review. Developed by John Bollinger, Bollinger Bands are an indicator that allows users to compare volatility and relative prices levels over a period of time. Bollinger Bands are volatility curves used to identify extreme highs or lows in relation to price. Basically, Bollinger Bands are made up of a 20-day SMA and two more curves corresponding to 2 standards of deviation above and below the 20-day moving average. Bollinger Bands are similar to moving average envelopes. Bollinger Bands are designed to capture the majority of price movement.