If you are into forex trading, you might have heard about Bollinger Bands. These are regarded as the best indicators for forex because traders can use them to determine the volatility in price actions. They can work with any kind of security and in nearly all the markets.
Bollinger Bands or BBs are easy to use, free and extremely reliable. When using this tool, you can know when the market prices have hit the extreme or near to the exploding point as well as whether the market is stuck or trending in a particular range. This tool is basically plotting the normal deviation below and above the simple moving average. In Forex, you can use a simple moving average to smooth out a price action.
How to use Bollinger Bands to trade Forex
When you plot the standard deviations below and above the moving average this will make an envelope to show the volatility of the market. If the bands widen, this indicates that the market is getting more volatile. On the other hand, the bands narrowing will show that the volatility is declining. Bollinger Bands are used widely to identify the oversold/overbought conditions in the market, in addition to confirming the deviation between the indicator and price action.
Here are some simple tips to in mind if you are using Bollinger Bands for forex trading:
Bollinger Bands have a default setting of 20 periods for the simple moving average. Two standard deviations would be set below or above and the bands will continue to decrease and increase in width as the volatility of the market goes up or down. Always remember that Bollinger Bands are either plotted below or above the simple moving average.
Another important thing to remember is that you need to modify the standard deviation of the BBs if changes are made to the periods for the simple moving average. Note that 21 or 20 period is the ideal setting, as less than 10 might not work out well. The time frame for Bollinger Bands can vary from monthly, weekly, daily to five minutes.
When the bands tighten, this usually leads to rapid price movements. Prices which move higher than the upper BB indicates strength and lower movements show weakness. Any movement outside of the band that is followed by a rapid retracement would indicate price exhaustion.
When using BBs for trading, it’s always a good idea to use one more technical indicator. RSI or Relative Strength Index is one of the technical indicators which work well with the Bollinger Bands.
Overall, it is very easy to identify a trending market if you are using Bollinger Bands for forex trading. The price will move to the upper band when the market trends up and go to the lower band when trending down.