Forex Trading Indicators: Applying Bollinger Bands, An Extremely Important Tool For Technical Forex Traders
Bollinger bands on currency trading charts are used just as on stock and options trading charts, as an indicator to make the trader aware of a new unfolding movement, breakout or trend. They are made up of three lines or bands.The middle band is a simple moving average over a certain number of periods, generally 20. The upper and lower lines are at a fixed number (usually 2) of standard deviations calculated with reference to the number of periods used for the center band.
Bollinger bands were discovered by John Bollinger in the 1980s. The rationale behind them is that prices will predominantly remain within 2 standard deviations of the mean, which here is the moving average used to plot the central line. This implies that as prices reach the upper and lower band lines, a reversal is likely to keep the prices within the bands.
They are also an indicator of volatility. Wider bands point to a more volatile market than narrow bands.
Traders use Bollinger bands in several various ways but these are the two most popular ones:
1. Identification of overbought and oversold markets
On the basis that prices are seeming to move within the bands, some traders will use Bollinger bands as an indicator to sell when the price closes above the upper line and buy when it moves below the lower line. Normally they intend to close their trade when the price returns to the central line.
Alertness is important here, however, as these movements outside of the bands may simply signal a powerful trend unfolding in that direction. So you could be caught on the wrong side of a strong price movements in some cases. John Bollinger himself recommended always checking against different indicator. Presumably the most effective for this purpose are non-oscillating indicators such as trend lines or chart patterns.
2. Identification of contraction and forecasting breakout
As we have seen, the bands will diverge and converge consistent with the volatility of the market over the measured past periods. When they converge so that their area becomes narrow, this is called contraction. Some traders will act assuming that contracting bands is a signal of a significant breakout and place both buy and sell orders outside the bands.
The danger here is that there can often be a false move where the prices will stretch outside the bands briefly before turning. Because of this reason some traders rather do not act on the first move outside the bands. Again you should always check against another indicator on your currency trading charts, or use forex signals as a checking tool. A forex signal is a market forecast and a trading recommendation, which can be used as a confirmation, especially if comes from a reliable forex signal provider.
Forex Trading Indicators: Applying Bollinger Bands, An Extremely Important Tool For Technical Forex Traders
The idea behind them is that prices will normally remain within 2 standard deviations of the mean, which here is the moving average used to plot the central line. This means that as prices reach the upper and lower band lines, a reversal is indicated to keep the prices within the bands.
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