10. How to use Bollinger Bands
Another tool to carry with you when you are in the Forex world. Bollinger Bands introduced by John Bollinger, are nothing but market indicators on the charts used for technical analysis. They are a set of two bands above and below the market price on a chart. Changes continuously happen in a Forex market and Bollinger Bands provide a means of measuring this amount of change happening to the price of a currency. Put in simple terms, provides a means of measuring the dynamic volatility in the market.
When Bollinger bands come close together, it indicates low volatility and is known as “the Squeeze”.
The upper and lower bands actually indicate the overbought and oversold prices. One of the common trading strategy is to buy the currency when price hits the lower band and sell when the price hits the upper band. In a market where price keeps bouncing between these bands, this strategy might work well. But what if there is a break out? This strategy won’t work.
As the prices increase or decrease Bollinger bands expand and contract accordingly to correctly indicate market volatility dynamically and thus creating a trend.
As you can see in the above diagram, whenever the market is slow, the volatility is low and hence the bands tend to come closer. As a trader keep in mind that whenever you see bands converging, a breakout may be on the way and hence follow the trend and take your position. It is always a good decision to find out a range in the market and then wait for the breakout.
If you see that candles start to go above the upper band, it means prices are going to go high and it can be a false sell signal. And if the candles start to break out below the lower band in the chart it means prices are going to go down.
Thus, Bollinger Bands can be very useful tools for identifying a trend and hence they play a very crucial role during Technical Analysis. There are lot of calculations using standard deviations and other concepts in coming up with the Bollinger Bands and for now you don’t have to worry about them at all. Just ensure that you understand how to use them during your analysis and be happy!