Currency Trading Analysis: Using Bollinger Bands, An Extremely Important Device For Technical Currency Traders

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Bollinger bands on forex trading charts are used just as on equities and options trading charts, as an indicator to make the trader aware of 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 periods, typically 20. The upper and lower lines are at a fixed number (usually 2) of standard deviations plotted referring to the number of intervals used for the center band.

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

They are also an indicator of amplitude. Wider bands show signs of a more volatile market than narrow bands.

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

1. Identification of overbought and oversold markets

On the basis that prices are seeming to fluctuate within the bands, numerous traders will use Bollinger bands as an indicator to sell when the price rises above the upper line and buy when it slides below the lower line. Normally they intend to close their trade when the price returns to the central line.

Caution is vital here, though, as these movements outside of the bands could just signal a powerful trend unfolding in that direction. So you could be caught on the wrong side of a strong price movements in some cases. John Bollinger himself advised on all occasions examining against different indicator. Presumably the most suitable for this purpose are non-oscillating indicators such as trend lines or chart patterns.

2. Identification of contraction and predicting breakout

As we have seen, the bands will diverge and converge in accordance with the volatility of the prices over the calculated past intervals. When they converge so that their area becomes narrow, this is called contraction. Some traders will act assuming 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 often be a false move where the prices will expand outside the bands shortly prior to turning. 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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