Bollinger Bands indicator in Forex Trading is another powerful indicator used to determine price action. Bollinger Bands technique was introduced by John Bollinger in the decade of 1980 and so this is named as Bollinger Bands. John Bollinger took advantage of the volatility and the price action to frame a clear picture. This picture helps in defining the lows and highs of the Forex market. This technique can also identify reversals in the market. The technique of Bollinger Bands use supply management, technical analysis and elements of statistics to determine normal price action. This technique consists of three bands, the upper band, the lower band and the middle band and you can use it in your real Forex account.
Without any action of buying or selling the security, the upper band of the Bollinger Bands should not be breached. Without any action of selling the security, the lower band of the indicator should not be crossed. Statistical methods like EMA or moving averages are used to determine the middle band in the indicator. EMA and moving averages are the two excellent tools to use because these tools depend on the current and historical price behavior of the securities. Bollinger Bands also encourage the traders and investors to study this method in combination with other technical analysis methods so that best prediction is possible. The standard deviation in price existing in the same period as the moving averages is used to calculate the indicator. The simple formulas for calculating the indicator are written below.
In the formulas above, the terms are described as
Upper BB -> Upper Bollinger Bands
Lower BB -> Lower Bollinger Bands
MA -> Moving Average
SMA -> Simple Moving Average
Simple moving average can be calculated by the formula given below.
The difference between the upper and lower Bollinger Bands shows the volatility in the trading.
When the distance between the bands is least then volatility is least and during the period of least volatility the shape in which bands are is known as squeeze. This means that the bands of Bollinger Indicator squeeze the price and it seems that the distance between the price levels is least or zero for a time period. The figure below indicates the Bollinger Squeeze.
The Indicator are useful to the traders because it performs three major functions explained below.
Spotting a New Trend and a Breakout
Market trades in low volatility trading range showing that market is low volatile but it is also a warning that market may move from low volatility to high volatility area. If prices go below or above the lower or upper trend then it indicates that a breakout may occur and a new Forex trend may develop. Based on this signal, traders may open a new position in the direction in which the breakout occurred and try and try to go with the trend. For example, red colored circle in the figure below shows an uptrend from point A, B and C after the end of a downtrend.
Timing of Entry in a Trend
Everyone wants to earn high profit and this can only be possible if your timing of entry is good. It will be waste to enter that time when there is not much move left and it is also risky to enter that time when the trend has just started because the breakout you saw may be a false breakout. So Bollinger Bands technique can help you to predict the correct time to enter a Forex trend. Always enter in trend direction and at the correct time. Correct timing of entry will earn you higher profit.
Spotting Market Reversals
If the top point of the band is touched, a reversal is expected. The price may reverse back to the middle of the band. If the bottom point of the band is touched, then also a reversal is expected. The price may reverse back to the top of the band. At this time the traders and investors can buy the currency in the hope of earning good profit. The width of the indicator depends on the market volatility and also gives clear indication to the traders about the possible price levels for the currency and what is the right time to enter the market. The red colored circle in the figure below shows the price reversal.
Bollinger Bands are very useful for the traders and investors but should be used in combination with other indicators. Traders and Investors should not use this tool in isolation.
How to use Bollinger Bands in Forex Trading platform MT4
Open a chart for any currency pair Click on:
Insert –>Indicators –>Trend –>Bollinger Bands
See the picture below to understand better.
After selecting the Bollinger Bands as shown above, the window opens as shown in the picture below.
Fill the values in this window as according to requirements and the Bollinger Bands will be automatically drawn on your chart. if you want to know more about Forex Trading Indicators you can visit our Forex Education category.