In the world of forex trading, trading indicator tools keep on emerging in a bid to make the market more robust. However, most of the new trading indicators are usually a variation of the indicators that have been in use for the longest time possible.
This article will look at the Bollinger bands as a trading indicator and how they can be effectively used in forex trading.
What are Bollinger Bands?
John Bollinger first developed Bollinger bands to find relative lows and highs in the forex market. Bollinger bands are widely used among traders as they are considered a versatile technical analysis tool.
How Do Bollinger Bands Work?
Bollinger bands use standard deviation, also known as a statistical measure, to establish where support or resistance levels lie with a particular band. Bollinger bands use the volatility channel concept, which plots lines below or above a dominant quantity of price.
Depending on how volatile or non-volatile a market is, these bands either widen or contract. The ability of Bollinger bands to measure the market’s volatility is essential as it provides vital information such as;
- The continuation or reversal trends
- Market merging periods
- Impending extensive instability breakout periods
- Potential price targets
- Possible market ups and downs.
Factors to Consider When Using Bollinger Bands
In order to avoid losses, it is essential to consider the below factors when trading forex using Bollinger bands.
I. Set Limits
Understanding how Bollinger bands work is essential to every trader. When using Bollinger bands to trade currency pairs, it is advisable to place sell orders when the upper band reaches its limit and place buy orders when the lower bands are at their limit.
Bollinger bands’ concept involves three bands; the lower band and the upper band, which revolve around a centered simple moving average, with the default value set at 20.
II. Reading Volatility
The Bollinger bands react and modify their shape when price fluctuations occur. When there is increased volatility, traders can capitalize by using the Bollinger bands, which indicates that new norms will be set.
Reading market volatility well can help traders from acquiring losses or even getting frustrated with the whole concept of forex trading.
Three essential Bollinger Bands strategies
Although various techniques are used in the implementation of Bollinger bands, we will look at some of the most popular in forex trading.
1. Market Trends strategy
When Bollinger bands are used as a measure of support and resistance, they can help the traders to identify entry and exit points. Using market trends to trade forex is relatively simple as it involves only three steps.
- First, as a trader, you have to identify the market trend
- Next, a trader makes use of both the lower and upper bands together with the price movement to identify entry points
- Lastly, the trader uses the respective upper and lower bands as target levels. To sell when the upper band hits the limit and to buy when the lower band hits its limit.
2. The Bollinger Band Squeeze strategy
In the Bollinger bands indicator, traders look out for the bands as they contract to indicate low or high volatility. The Bollinger band squeeze generally looks for breakouts that can either be below or above the band depending on the market trend used as entry signs.
Trading with Bollinger bands squeeze involves;
- Looking out for contracting bands showing low volatility
- Waiting for the lower or upper band to breakout
- Closing the deal when the prices reach moving average.
3. Breakout Strategy
The breakout strategy mainly focuses on the identification of possible trend continuations or reversals. Trend continuations and reversals usually take place when the price goes outside the lower and upper bands.
In a nutshell, Bollinger bands are a technical indicator tool that helps the trader know when a security or currency pair has been oversold or overbought.
When it comes to Bollinger bands, the rule of the thumb is, prices are considered overbought on the upside. This happens when the prices touch the upper hand. On the other hand, prices are considered oversold when the lower band touches the downside.
Being able to interpret and knowing how Bollinger bands indicators work, can help you identify entry and exit points, thus avoiding losses.