Bollinger Bands Are a Useful Technical Indicator for Traders
The Bollinger Bands (invented by John Bollinger) are a great technical indicator to assist forex traders with trade entry and exit points. Often used to determine “overbought” and “oversold” levels, the bollinger bands focus upon current price and volatility over a period, and consists of three different dynamic lines.
How can Forex Trades Use Bollinger Bands?
The bollinger bands' three lines are quite simple; the middle is a moving average, typically a 20-period average. The outer lines are based upon standard deviation, with the upper line typically being twice the period standard deviation, and the bottom line being negative twice the period standard deviation.
There are typically two strategies based around the bollinger bands. The first is an “overbought” / “oversold” strategy. The second is a retracement of volatility strategy. We will give a brief overview of these strategies. As always, if you wish to use this strategy use a demo account to gain realistic expectations of the strategy.
To trade the Bollinger Band overbought/oversold strategy first establish the trend direction: is it a bullish or a bearish market? For this strategy you want to trade only in the direction of the trend. Once you’ve established direction wait for price to pull back into the appropriate outer band. In a bull market this would be the bottom band, and in a bear market this would be the top band.
Once price has pulled back, wait for the next candlestick/bar to close in the direction of the trend. The strategy indicates to open a position on the candlestick confirmation, with the stop placed above/below the pullback, and targeting the previous high/low.
Below is an example of this strategy in a bearish market.
The second popular strategy with bollinger band is trading the retracement of a volatile move. After bollinger bands widen out their range due to volatility they often contract and give a counter trend trade opportunity. Wait for the bands to contract, find an entry zone, and place stops above or below the zone and outside of the bands. Target a 50% retracement of the volatile move.
An example of this with bullish volatility and a bearish trade is shown below.
It is always important in trading to conduct your own backtesting and research to develop a realistic set of expectations surrounding any strategy.