Currency Trading Indicators: Applying Bollinger Bands, An Essential 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 alert the trader to a new forming 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 intervals, normally 20. The upper and lower lines are at a certain number (usually 2) of standard deviations plotted with reference to the number of periods used for the center band.
Bollinger bands were invented by John Bollinger in the 1980s. The assumption behind them is that prices will ordinarily stay within 2 standard deviations of the median, which here is the moving average used to plot the middle line. This means that as prices reach the upper and lower band lines, a reversal is anticipated to keep the prices within the bands.
They are also an indicator of volatility. Wider bands signal a more volatile market than narrow bands.
Traders use Bollinger bands in a number of various ways but these are the two most favored ones:
1. Pinpointing of overbought and oversold market conditions
On the basis that prices are likely to fluctuate within the bands, several traders will use Bollinger bands as an indicator to sell when the price closes above the upper line and buy when it drops below the lower line. Typically they intend to close their transaction when the price nears to the central line.
Caveat is necessary here, though, as these movements outside of the bands may simply indicate a strong trend unfolding in that direction. So you could be caught on the false side of a powerful trend in some cases. John Bollinger himself advised frequently checking against another indicator. Most likely the most suitable for this purpose are non-oscillating indicators such as trend lines or chart formations.
2. Identification of contraction and foretelling breakout
As we have seen, the bands will diverge and converge according to the volatility of the prices over the measured past periods. When they converge so that their area becomes narrow, this is called contraction. Some traders will act on the basis that contracting bands is an indicator of a powerful breakout and place both buy and sell orders outside the bands.
The danger here is that there can frequently be a misleading break where the prices will expand outside the bands briefly before reversing. For 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.
Currency Trading Indicators: Applying Bollinger Bands, An Essential 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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