Currency Trading Indicators: Using Bollinger Bands, An Essential Device For Technical Foreign Exchange Traders 


Bollinger bands on forex trading charts are used just as on equities and options trading charts, as an indicator to alert the trader to a new unfolding movement, breakout or trend. They are made up of three lines or bands.

The middle band is a simple moving average over a certain number of intervals, generally 20. The upper and lower lines are at a certain number (usually 2) of standard deviations calculated referring to the number of intervals used for the center band.

Bollinger bands were invented by John Bollinger in the 1980s. The reasoning behind them is that prices will mostly stay within 2 standard deviations of the base, which here is the moving average used to plot the central line. This means that as prices reach the upper and lower band lines, a reversal is indicated to maintain the prices within the bands.

They are also an indicator of fluctuation. Wider bands indicate a more volatile market than narrow bands.

Traders use Bollinger bands in several various ways but these are the two most favored ones:

1. Pinpointing of overbought and oversold markets

On the basis that prices are likely to remain within the bands, several traders will use Bollinger bands as an indicator to sell when the price rises above the upper line and buy when it drops below the lower line. Normally they intend to close their trade when the price approaches to the central line.

Attention is important here, however, as these movements outside of the bands could just indicate a powerful trend unfolding in that direction. So you could be caught on the false side of a strong trend in some cases. John Bollinger himself recommended all the time examining against another indicator. Presumably the most suitable for this purpose are non-oscillating indicators such as trend lines or chart formations.

2. Identification of contraction and predicting breakout

As we have seen, the bands will diverge and converge based on the volatility of the market over the calculated past intervals. When they converge so that their area becomes narrow, this is called contraction. Some traders will act on the basis that contracting bands is a signal of a powerful breakout and place both buy and sell orders outside the bands.

The danger here is that there can frequently be a false break where the prices will stretch outside the bands shortly prior to reversing. Because of this reason some traders rather do not act on the first move outside the bands. Again you should always check against another indicator on your currency trading charts, or use forex signals as a checking tool. A forex signal is a market forecast and a trading recommendation, which can be used as a confirmation, especially if comes from a reliable forex signal provider.

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