How to use Bollinger Bands for Forex trading?

Indicator | by ForexCycle.com | Tuesday, 20 January 2009 06:54 UTC

Discovered by John Bollinger, the Bollinger Bands is a simple moving average based tool that allows people in Forex trading to estimate the instabilities and trend in the Forex market. Let us have a brief look at the concept of Bollinger bands and how you can use it to improve your Forex trading strategy.

What are Bollinger Bands?

Bollinger bands consist of two volatility bands enveloping either sides of a simple moving average. The bands are calculated based on the standard deviation of the price during the same period as the moving averages. This standard deviation is plotted on either sides of the moving average. The distance between the upper and lower Bollinger bands shows the standard deviation of price or the volatility of the currency traded. As this price volatility increases, the outer bands move further away from the longer-term average. If the volatility decreases the bands move closer to the moving average.

Normally, the price increases slowly with time, but sometimes due to nervous or greedy traders, the price will spike suddenly. Such spikes will not last for long and the prices will normally come back to reasonable values (or the moving average of the Bollinger bands). Such instability of the outer bands will give an indication to traders on the volatility of prices and the extent of variation of the price from the normal value.

Using Bollinger Bands in Forex trading:

  • When the market is secure, there is less volatility in prices. On the other hand, if the market is insecure it reflects in a higher volatility of prices.
  • You can use the Bollinger Bands as a tool to find out the safest time to employ the trading signal.
  • During a strong trend, prices will have a tendency to take a plunge to the mid band; this may be the best time to apply the trading signal.
  • The measure of how far the standard deviations of the outer bands have moved away from the average mean is an indication of how much the price has deviated from normal value.
  • Whenever you see the bands spread wide out from the mean value, you can take this as a sign to exit the market and lock-in and protect all the hard earned profits from getting wiped out by the instabilities in the market.
  • You need to be extra careful whenever the bands are showing signs of sudden increase in volatility, as a new trend can soon follow.
  • Do not depend solely on Bollinger bands for timing the market or to enter trading signals. Instead you can use it in combination with other methods like trend lines and momentum indicators.

Success in Forex trading has a lot to do with how alert and sensitive you are about the currency volatility. Bollinger Bands is a wonderful tool that you can use to make better decisions in your trading. Use this tool the right way and you will surely reap big profits in your Forex trading.

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