Those who trade Forex will need to use a variety of tools to get their trading off the ground and working for them. One of the tools to include in any Forex toolbox is Bollinger Bands. This is a tool used by most seasoned traders, and even by those who are still getting their feet wet and trying to figure out how these markets work in the first place.
It is important to have an understanding of what is going on with Bollinger Bands if you hope to take your trading to the next level, and people deserve to know a little about what these bands are and why they are so important.
What Are Bollinger Bands?
How cool would it be to have an indicator named after you? For John Bollinger, this is reality. He invented the Bollinger Bands as a measurement of if a particular currency pair is overbought or oversold, and to identify if conditions in the market were overbought or oversold. The long and short of it is that the tool is meant to help determine when the market is relatively quiet, and when things are starting to heat up.
You probably want to know when either of these conditions is in play as it will help you decide exactly how to respond with your trading. It very well could be the case that you need to adapt your strategy based on the volatility that is present in the market at the time. When things start to get a little hairy in the market, it is nice to step back and reassess exactly where you are and how you can respond to all of the noise.
What Do Bollinger Bands Look Like?
The Bollinger bands indicator is a lot simpler looking than many other types of indicators. This is because it simply features a top line, a bottom line, and a line drawn in the middle. The upper line is meant to be the top of the range, the middle line is a baseline of sorts, and the bottom line is useful as the bottom of the current range.
When a currency pair breaks through either the upper line or the bottom line, it may be signaling that there is a bigger move yet to come. The reason is that a move like that is an indication that the trend in the market has changed in some marked way. The currency pair is giving off all of the signs of having made a dramatic change one way or the other when this type of thing happens, and it is important to perk up and take note of things like this.
Some traders like to see two standard deviations of the Bollinger Bands — called a double Bollinger — to gauge price action:
An important thing to keep in mind when using the Bollinger bands as part of your trading strategy is that price movement in a currency pair tends to drift towards the middle of the Bollinger bands at all times. They are designed to be an average, and the currency pairs like to try to get themselves towards the average of recent price movement. This doesn’t always apply, of course, because the start of a new trend or a big piece of news that hits the wires about the currency pair can certainly throw this concept out the window. That said, the middle of the Bollinger bands is naturally where the currency pair would like to travel towards if at all possible.
Given all of this, it is important to remember that the bands are meant to provide some basic details about the recent price movement of the currency pair, but they are not always going to tell the entire story. You are getting some important information about the recent price movements within the pair, but don’t forget that there are other factors that go into what drives a currency pair. Do not expect the price to remain within those bands forever. It would be impossible to start a new trend in either direction if this was the case. Therefore, you should use the bands as a way of judging what recent moves the pair has made, but don’t put your entire trading account on the line expecting the pair to always bounce back towards the middle.
Another thing that sometimes happens with the Bollinger bands is that there is a squeeze that throws the currency pair dramatically in one direction or the other. When the squeeze takes place, the currency pair will rocket either upwards or downwards compared to where it had recently been within the bands. This sometimes happens after long periods of contraction in the market.
If the pair has just been bouncing back and forth between the bands for some time, then it may be prepared to squeeze out of those bands and head dramatically in another direction. Be very careful about assuming that the Bollinger bands will always hold when you are trading. If you make the wrong move, the squeeze could wipe you out in a hurry.
Your best bet is to use the Bollinger bands in combination with other indicators to get the clearest picture of what is going on. The bands are not meant to be the written word and never change. They are a dynamic indicator just like so many others.
Therefore, you ought to respect what the Bollinger bands are telling you, but you shouldn’t assume that you are to obey their dictates and never assume that the currency pair will move outside of the bands. It happens all the time, and you should position yourself to take advantage of it when it does occur if you would like to get the most from your trading experience. You need to keep the Bollinger bands active, but don’t believe for a moment that they are the only important indicator.