It’s time to take a look at Bollinger bands. And no, unfortunately, it’s nothing to do with champagne.
Bollinger bands are a technical analysis tool invented by John Bollinger. (Who also wrote the imaginatively titled book Bollinger on Bollinger Bands). Basically, they work by measuring the “highness” or “lowness” of a price, compared to previous trades.
They’re made up of a moving average with upper and lower bands based on standard deviations.
FOR EXAMPLE…
A common setting for a Bollinger band is a 20 period moving average with the upper and lower bands set at 2 standard deviations.
Why Use Standard Deviations?
Standard deviations can be used to gives you an idea of how much the price you are looking at varies from the average over a period of time.
In a totally random set of results, you would expect to see 95% of all results falling within 2 standard deviations, and more than 99% to be within 3. So applying this to trading, IF price is completely random, then there’s a very good chance that the next price the market makes will fall somewhere between the upper and lower Bollinger bands.
Of course, this all depends on price being random, and whether this is true or not is an argument for another day. However, even if price is not random, Bollinger bands are still useful to provide an indication of how far price is likely to move in a certain period.
How To Make Bollinger Bands Work For You
Bollinger bands can be applied to both trending and non-trending markets using a slightly different strategy for each environment. Let’s take a look at both, and the best ways to analyse them…
1. Trending Markets
In a trending market, price will be pushing in a particular direction, pushing on either the upper or lower Bollinger band, depending what direction it’s moving in.
This is shown in the chart below:
HOW TO DO IT:
In a trending market, the best way to use Bollinger bands is through the pull back strategy.
Bollinger bands can allow you to use a pull back towards the moving average to enter into the direction of the trend.
WHY IT’S USEFUL:
Using Bollinger bands in this way allows you to run tight stops, in order to capture the trend.
DON’T FORGET:
This works particularly well on lower time frames. When used with good risk/reward management, it can be a really good strategy for use on highly traded pairs (like the EURUSD).
2. Non-Trending Markets
In a non-trending market (also known as range bound or choppy), Bollinger bands can act as barriers to price, as shown in the chart:
HOW TO DO IT:
In a range bound or low volatility environments, you need to use Bollinger bands as a guide to how the price may move. You can do this using the fading strategy.
To do this, you need to look for an extreme price movement in low volatility, and then take the opposite position. Then, plot the 20 period moving average, and the 2 and 3 standard deviations on the chart, as shown below:
The final step is to look for the price to hit the outer Bollinger, then move back into the Bollinger range. It if breaks or closes above the inner Bollinger, you can then get in the direction towards the moving average.
Here’s an example of what might happen:
WHY IT’S USEFUL:
This strategy allows you to use relatively tights stops on lower time frames to capture a fade in the opposite direction.
DON’T FORGET:
To make sure you’re in a low volatility environment before using this strategy. (You can do this using ADX or an Awsome Oscilator, or get clues from your moving averages or MACD).
All comments, charts and analysis on this website are purely provided to demonstrate our own personal thoughts and views of the market and should in no way be treated as recommendations or advice. Please do not trade based solely on any information provided within this site, always do your own analysis.
Editors’ Picks
AUD/USD stands tall just below its highest level since January touched on Wednesday
The AUD/USD pair holds above the 0.6700 mark during the Asian session on Thursday. The Australian Dollar continues to draw support from the upbeat domestic Retail Sales data released on Wednesday, which strengthened the case for a rate hike by the Reserve Bank of Australia.
EUR/USD lurches higher after US data dumps Greenback
EUR/USD found a leg up on Wednesday, climbing briefly above the 1.0800 handle after a broad miss in US economic figures hinted at further signs of a weakening US economy, sparking fresh hopes for an accelerated pace of rate cuts from the Federal Reserve and markets flowing out of the safe haven US Dollar.
Gold price remains supported by rising September Fed rate cut bets
Gold price oscillates in a narrow band during the Asian session on Thursday. The softer US economic data released on Wednesday pointed to a slowing labor market and economic momentum, which lifted bets for an interest rate cut by the Federal Reserve in September.
What to expect from altcoins as ETH ETF approval draws closer
As the crypto market continues consolidating on Wednesday, altcoins show mixed signals ahead of the spot ETH ETF launch. Many have predicted that the alt season may not occur in this cycle following the market lull. However, two key metrics suggest otherwise.
Could the post-UK elections market moves resemble 1997 and 2010?
Thursday's UK elections expected to bring political change. Similar developments in both 1997 and 2010 weighed on the Pound. History points to a significant easing in Pound volatility across the board. Recent FTSE 100 performance matches the 2015 pre-election moves.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.