Do you know how to trade Bollinger bands Forex style? They’re a great indicator for direction as well as support and resistance. In fact, if a stock is outside of the bands, you know either to wait for an entry or get out. The bands like to keep price contained. Almost like a rubber band. If price gets outside of it in either direction, it’s going to snap back.
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How to Trade Bollinger Bands in Forex
Bollinger Bands are a popular technical indicator that was developed by a technical analyst named John Bollinger in the 1980s. The indicator helps traders to determine possible buy and sell levels as well as possible big movements in an asset price.
To understand Bollinger Bands first you need to have some information about standard deviations. Standard deviation is just a measure of how far away an asset price is from its average or typical price.
One standard deviation is a little bit higher or lower than the average or typical price of an asset. And this happens frequently. Two standard deviations mean a lot higher or lower than the average or typical asset price. This happens occasionally.
Three standard deviations is a whole lot higher or lower than the average or typical stock price and this happens rarely but it does happen in a market. In regular market conditions, an asset or instrument price will likely stay within one standard deviation that’s 68.2% of the time.
The price will stay within two standard deviations that is 95.5% of the time. Finally, the price will stay within three standard deviations that’s 99.7% of the time.
How Bollinger Bands Work
When you plot Bollinger Bands on a chart, there are three lines; a middle, upper, and lower band. The default values for the Bollinger band are 20, 2. That means the middle line is simply the 20-day moving average of the asset. And both bands are two periods apart above and below.
The standard deviation represents how far away the asset price is from the average price. The upper band is two standard deviations above the average price while the lower band is two standard deviations below the average price. Since it’s two standard deviations, if the market goes by the book then 95.5% of the price movement would remain between the Bollinger bands.
Realistically speaking, the market isn’t always normal or rational in its behavior. From practical experience, the market is still expected to remain between the bands 90% of the time.
Since an asset price is contained within the lower and upper bands, some traders prefer to buy when the price touches the lower band; and sell the asset when the price touches the upper band. This method works better with less volatile markets since at the time there are no major moves. And the market remains within the bands.
But remember there’s still a possibility that even in the less volatile times the market can bust through either the upper or lower band. It could be a piece of fundamental news; like the change in the interest rate or political instability.
To trade Bollinger Bands Forex style, you’ll notice that the bands will squeeze or expand many times. When the upper and lower bands remain squeezed for a while, volatility is lower. Typically this is followed by a big move either upwards or downwards. Finally, when the bands are expanded it shows the market is volatile.
Trade Using Bollinger Bands
One way to trade Bollinger bands is when the market touches down the lower or upper band. You can buy when the price is at the lower band and keep your take profit either in the middle or just below the upper band. The stop-loss for these long trades remain just below the lower band.
Similarly, when the price touches the upper band you can plan to sell while targeting the middle or the lower band. Once again the stop would be just above the upper band.
The other way to trade using Bollinger bands would be to look out for the breakouts especially when the bands are narrowed or squeezed. Although it’s difficult to find which way the market would breakout. Use them for support and resistance too.
However, common price patterns and other technical tools like oscillators can provide valuable information on the overbought and oversold zone which is really helpful to identify the direction of the breakout.
Below is a real-time example of Bollinger Bands plotted on the daily EUR/USD chart. You can see the price has contained the majority of the time within the bands except for a couple of breakouts. As indicated on the chart when the price has hit the lower band it goes back up.
And when it hits the upper band it falls back. There are also a couple of breakouts in the market that can be identified earlier using other technical indicators.
You can trade Bollinger Bands in Forex for the direction they provide. When volatility occurs, it’s best to know when to get in or out of a trade. And which direction you should keep an eye on. Make sure you get confirmation when it comes to directional trading. You don’t want to get in on the direction.