Forex Trading and How To Apply Bollinger Bands

By: Robin Parker

One of the most popular technical indicators that forex traders use in the FX market is Bollinger Bands. These bands are used to predict overbought as well as oversold levels. Bollinger Bands are effective tools to determine the volatility in the markets. The Bands were developed by John Bollinger during the 1980s. In addition to determining volatility, these bands also indicate the standard price deviation.

The Bollinger Bands are lines that are placed on either side of the simple moving average. These lines are places at standard deviations below and above and approximately 95% of the movement in currency price in forex trading takes place in between the 2 levels. The Bollinger Bands contract as well as expand in response to the oscillations in the price volatility.

The bands expand when volatility increases and they contract when the volatility decreases. The width of the bands is directly proportional to the volatility. In other words, when volatility is high, the bands are wide apart. And when volatility is less, the Bollinger bands are close to each other. In case of Bollinger Bounce, the price returns to the middle of the bands. The Bollinger Bands act as “mini support and resistance levels”. They are also referred to as volatility bands.

How are Bollinger Bands used in forex trading?
Bollinger Bands can be used by forex traders in the following manner:

  • Greed and Fear in forex trading

    When the Bollinger Bands are away from the mean average price, these bands can be used to exit the market and you can also lock in profits.
  • Trends in Motion A trend in motion has a tendency to dip back to the middle of the band. And you can use this indication to enter new positions that are in line with support and resistance. The mid band gives you “low risk buying opportunity”.
  • Watch out for price breakout Volatility is usually low when the prices are trading tight. So, you can take this opportunity to predict a trend in the market and watch out for price breakouts. In currency trading, a phase of low volatility is usually followed by a period of high volatility.

So, the usefulness of Bollinger Bands cannot be undermined. These bands can be used to predict volatility in the forex market. These work best when clubbed with momentum indicators, trend lines that are used for confirming trading signals.