What are Bollinger Bands?
Bollinger Bands were created in the 1980s by financial analyst John Bollinger, and they measure price action and volatility.
Bollinger Bands are a chart overlay technical indicator, meaning traders will add them within a price chart rather than below the chart.
Bollinger Bands measure volatility based upon standard deviations of the price over a defined previous period.
Traders can use them to judge market conditions, for example, trending or ranging price behaviour. Advanced traders use Bollinger Bands to spot reversals. Bollinger bands can also indicate dynamic support and resistance.
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Bollinger Bands Calculation
Bollinger Bands consist of three bands: the middle band, the upper band, and the lower band. The Bollinger Band default period setting is usually 20 trading days. Most Forex traders use a simple moving average (SMA) for the middle band because the standard deviations also use an SMA.
Some traders prefer to substitute the SMA with an exponential moving average (EMA), and seasons traders use various settings for their moving averages.
Bollinger Bands Formula
- Middle Band = 20-day simple moving average (SMA)
- Upper Band = 20-day SMA + 2.0 20-day SMA standard deviations
- Lower Band = 20-day SMA - 2.0 20-day SMA standard deviations
Noteworthy:
- Practically all charting packages include a Bollinger Bands indicator.
- John Bollinger recommends 2.1 standard deviations for a 50-day SMA and 1.9 standard deviations for a 10-day SMA for the Bollinger Bands period settings
- The Bollinger Bands MT4 indicator handles all the calculations, and Forex traders may use it as a chart overlay indicator displayed over the price, without needing to worry about the calculations.
What can Forex traders learn from Bollinger Bands?
One reason technical analysts use Bollinger Bands in Forex is their ability to indicate changes in volatility.
They give short-term traders a time-tested and reliable tool to build their trading strategies.
Forex traders can also use Bollinger Bands to:
- Identify if price action is ranging or trending
- Spot overbought and oversold conditions
- Define probable high and low prices for currency pairs
- Assist with pattern recognition
- Compare price action to various technical indicators
- Create trading signals
- Use in algorithmic trading solutions, for example, Bollinger Bands MT4 EAs
- Generate trading signals for advanced traders via Bollinger Bounce and Bollinger Squeeze
- Identify periods of high and low volatility based on the distance between bands
.jpg "Reading Bollinger Bands on a Forex Price Chart")
Reading Bollinger Bands on a Forex Price Chart
Bollinger Bands in Forex Trend and Fading Strategies
Bollinger Bands offer Forex trend followers a valuable tool. Advanced traders can also use them as a basis for reversal strategies or fading trends, or as part of a Bollinger Bands option strategy. It is much easier to be profitable trading trends than fading them, which is why counter-trend trading is better left to more experienced traders.
How to use Bollinger Bands in trend following:
[coloredbox_ blue] The most efficient method is to use a multiple Bollinger Bands Forex trading strategy with two Bollinger Bands, one with 2.0 standard deviations and a second one with 1.0 standard deviation.
- When price action trades between the upper bands of both Bollinger Bands deviations, the likelihood is of an extended uptrend.
- When price action trades between the lower bands of both Bollinger Bands deviations, the potential of an extended downtrend is dominant.
- Trend traders should remain patient and stay on the sidelines if price action trades elsewhere between the bands
- Traders can buy a currency pair if it remains within the upper bands of both Bollinger Bands and sell if the asset trades between both the lower bands.
- Exits depend on individual preferences, but a breakdown or breakout below and above the middle band followed by a failed reversal offers an indication of a weakening trend and can be used as an effective exit signal.
- Stop losses are typically set just the other side of the middle band.
How to use Bollinger Bands in fading trends (counter-trend trading):
Using the same two Bollinger Bands chart overlay, Forex traders should look for a breakdown or breakout below or above the middle band, against a previously established trend.
- Forex traders can short a currency pair following a reversal of the breakdown below the middle band once price action tags the upper band of the Bollinger Bands with the 2.0 standard deviation setting. Long trades can be entered following the same setup in reverse.
- Exiting reversals and stop losses depend on the risk management of individuals, but a confirmed breakdown or breakout beyond the middle band tends to be an effective signal to get out of a trade.
How to Read Volatility with Bollinger Bands in Forex
Bollinger Bands show standard deviations, so Forex traders can use them to read volatility, because deviation is a measure of volatility. When volatility increases, the upper and lower bands within a Bollinger Bands indicator widen. The upper and lower bands converge on the middle band as volatility decreases, known as a Bollinger Squeeze, which tends to generate the most reliable trading signal of any Bollinger Bands Forex strategy. A price breakout or breakdown following a Bollinger Squeeze generally extends for a prolonged period, allowing Forex traders to use them as effective trade entry signals, if they match what is happening on higher time frames.
What is the Difference between Bollinger Bands and Keltner Channels?
Bollinger Bands and Keltner Channels are very similar technical indicators, as both are based upon volatility and average prices.
The two distinct differences between Bollinger Bands and Keltner Channels are:
- Bollinger Bands use standard deviation, while Keltner Channels are based upon average true range (ATR).
- Keltner Channels tend to generate more trading signals than Bollinger Bands as they measure volatility based on range. This makes some analysts think that Bollinger Bands are a more reliable indicator.
What are the Most Profitable Bollinger Bands Forex Strategies?
Bollinger Bands in Forex are used as the basis of several trading strategies, but it is worth highlight three of what are widely seen as the most profitable strategies in Forex based on Bollinger Bands below.
Overbought and Oversold Bollinger Bands Forex Strategy
- Best suited for range trading with well-established support and resistance levels. Relies on the principle that price is likely to revert to its mean (average).
- A breakdown below the lower band can indicate oversold conditions, giving a signal to enter a long position.
- A breakout above the upper band can indicate oversold conditions, giving a signal to enter a short position.
- Only taking trades in the direction of the trend on a higher time frame will improve results.
- Traders should not use this strategy when the market is trending.
Bollinger Bounce Forex Strategy
.jpg "Bollinger Bounce Forex Strategy in a Downtrend")
Bollinger Bounce Forex Strategy in a Downtrend
- The Bollinger Bounce strategy relies on mean reversion, where the middle band acts as support in an uptrend and resistance in a downtrend.
- In an uptrend, Forex traders can buy a currency pair when price action bounces lower and onto the middle band following a touch of the upper band and a higher high.
- In a downtrend, Forex traders can sell a currency pair when price action bounces higher and onto the middle band following a touch of the lower band and a lower low
- Bollinger Bands can act dynamic support and resistance
- Beginner traders should use the Bollinger Bounce in ranging markets, while advanced traders can also deploy it in trending markets.
- Higher time frames, for example, the D1 or H4, create more reliable trading signals than those generated on shorter time frames.
Bollinger Squeeze Forex Strategy
.jpg "Bollinger Bands Squeeze Forex Strategy in a Trend Reversal")
Bollinger Bands Squeeze Forex Strategy in a Trend Reversal
- The Bollinger Squeeze trade entry signal is shows by a narrowing of the bands followed by a price breakout or breakdown with a spike in volatility (and ideally volume, if data is available).
- The Bollinger Squeeze strategy can either confirm a continuation of a previous trend after a pause, or a trend reversal.
Final Thoughts
Bollinger Bands provide traders with valuable information about volatility, average price levels, and how far a price is likely to move up or down under current market conditions.
Traders must understand that Bollinger Bands are a tool assisting with technical analysis and not an indicator that offers 100% reliable or automated trading signals.
Trading based only on signals generated by the various Bollinger Bands Forex strategies usually fails to provide sustainable profits. However, if these strategies are used together with other indicators or methods of analysis, they can work as the core of a profitable trading strategy.
Particularly effective methods are Bollinger Squeeze signals within a longer-term trend in the direction of the trend, and trend trading major Forex currency pairs with multiple (double) Bollinger Bands.
FAQs
Do Bollinger Bands work in Forex?
Bollinger Bands can work in Forex, like other technical indicators, but success depends on the interpretation and discretion of the individual Forex trader. Bollinger Bands cannot create 100% accuracy or automatic trading signals.
How do you trade Forex with Bollinger Bands?
Bollinger Bands measure volatility and use standard deviations. Forex traders can use them as tools for range trading, trend trading, and reversals.
How does the Bollinger Band work?
The Bollinger Band consists of three bands, where the middle band acts as a baseline. The upper and lower bands are 2 standard deviations above and below the middle band, but traders can alter the deviation settings. Bollinger Bands measure volatility.
Are Bollinger Bands reliable?
Bollinger Bands can provide reliable insights concerning volatility and trends but cannot work with 100% accuracy, like any other technical indicator.