Bollinger Bands Technical Analysis and Bollinger Bands Forex Trading Signals
Developed by John Bollinger
Bollinger bands are formed by three lines. The middle line is a Moving Average - 20 period Simple Moving Average.
The bands are then plotted at a distance away from the moving average These are the bands that form the lower and upper lines.
The distance where the bands are plotted is determined by another indicator called the standard deviation. Standard deviation is a measure of volatility in the forex market or that of a currency pair.
Since the market volatility keeps on changing, the standard deviation will keep varying, and since Bollinger bands are plotted using the standard deviation the distance of the bands will keep on adjusting themselves to the market conditions.
When the markets become more volatile, the bands widen and they contract during less volatile periods.
The 3 Bands are designed to encompass the majority of a forex currency price action. The middle band forms the basis for the trend, typically a 20-periods simple moving average.
This band also serves as the base for the upper and lower bands. The upper band's and lower band's distance from the middle band is determined by volatility. The upper band is plotted at +2 standard deviations above the middle band while the lower band is plotted at -2 standard deviations below the middle band.
Technical Analysis and Generating Signals
- Bands provide a relative definition of high and low
- Used to identify periods of high and low volatility
- Used to identify periods when prices are at extreme levels
Consolidation - the Squeeze
The bands tighten as volatility lessens, this identifies periods of consolidation. Sharp price break-outs tend to occur after the bands tighten.
Continuation Signal - the Bulge
If prices break through the upper or lower band move outside the bands a continuation of the current trend is expected.
Reversal Signals - Double Tops and Double Bottoms
Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend
The Head Fake- Whipsaw
Forex traders should be on the lookout for false breakouts known as whipsaws or head fakes.
Price often breaks out in one direction immediately following the Squeeze causing many traders to think the breakout will continue in that direction, only to quickly reverse and make the true, more significant breakout in the opposite direction.
Traders acting quickly on the initial breakout often get caught on the wrong side of the price action, while those traders expecting a "false breakout" can quickly close out their original position and enter a trade in the direction of the reversal. It is always good to combine Bollinger bands with other confirmation Indicators.