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What are Bollinger Bands?

The Bollinger bands can help identify overbought and oversold market conditions, protecting you against placing any orders that could lead to losses. It is also an effective tool to locate breakouts and breakdowns in a volatile market and provides confirmed market signals and price actions when used with other indicators.

Understanding Bollinger Bands

Bollinger Bands in Forex trading is a technical analysis chart indicator used for measuring market volatility. It is plotted two standard deviations above and two standard deviations below the currency pair’s average price. This helps the traders to understand whether the currency pair prices are low or high on a relative basis and in turn letting them know if the market is overbought or oversold.

Bollinger Bands graphic graphic

How do Bollinger Bands work?

The Bollinger Bands tend to squeeze when the market is less volatile and send a sharp price move signal in the market's direction. Such price moves lead to a price trend. However, when you notice the bands separating rapidly, it sends a more volatile market signal that leads to an end in an existing trend. The Bollinger Bands consist of three lines:

  • The simple moving average line
  • The lower band, two standard deviations below the simple moving average line
  • The upper band, two standard deviations above the simple moving average line

How do these bands send a signal to the trader?

  • When the currency pair prices touch the lower band and cross the moving average line from above, the upper band is known to be the profit target in that time period
  • When the currency pair prices touch the upper band and cross the moving average line from below, the traders receive an entry point signal at the lower band

How to calculate Bollinger Bands?

  • Calculate the 20-day simple moving average by adding the closing prices of the currency pair in the last 20 days and dividing it by 20 (time period).
  • Calculate the standard deviation of the currency pair price that you want to trade by determining how far away each day’s closing price is from the average and squaring the sum of all deviations before dividing it by the time period. The standard deviation will be the square root of the answer obtained.
  • To obtain the lower band, multiply the standard deviation that you have calculated by 2 and subtract this number from each currency pair price along with the simple moving average price.
  • To obtain the upper band, multiply the standard deviation obtained once again and add this number from each currency pair price along with the simple moving average price.
  • When you have the upper and lower bands ready, you can monitor the currency pair prices moving along the bands.
  • The closer the currency pair prices move to the upper band, the more overbought is the market condition.
  • However, the closer the currency pair prices are to the lower band of the chart, the market is known to be more oversold.

Top 5 Bollinger Band Trading Strategies

1. Oversold Bollinger Band Trading Strategy

As soon as the currency pair prices go below the lower band of the Bollinger Bands, they are said to have fallen a lot more than expected and tend to bounce back. This results in an oversold market condition that signals the trader to buy more of that currency pair and profit from the increasing prices thereafter.

2. Overbought Bollinger Band Trading Strategy

In the Overbought Bollinger Band trading strategy, the currency pair prices shoot up and increase beyond the upper band of the chart pattern. This results in an unexpected increase in the prices that is followed by a price reversal. This sends an exit signal to the traders in order to maximise their profits and minimise losses by selling the currency pair at the highest available price.

3. Squeeze Bollinger Band Trading Strategy

The Squeeze Bollinger Band trading strategy occurs whenever the currency pair prices move extensively in the market, and immediately after the rapid movement, they start to move sideways to consolidate tightly. In this situation, both the upper and lower bands come closer to each other, telling the trader that the market is volatile. The prices then make a much significant move in either the upward or downward direction, with high volume. The prices move in the direction of the breakout, sending profitable entry or exit signals to the trader.

  • A stop-loss order can be placed right outside the tight consolidation at the breakout’s opposite side to minimize losses
  • A buy or sell order can be placed as soon as the price goes beyond the upper band or below the lower band
4. Swing Trading Bollinger Band Trading Strategy

The Bollinger Band Swing trading strategy provides the traders with the most profitable entry and exit trading levels. In this strategy, it is best advised for the traders to place trades right after the two bands come together.

  • Both bands must face the opposite direction while coming together to ensure that you can benefit from the swing trading strategy
  • Since two bands coming together means that the market is less volatile, it is always followed by larger price moves in the future

After the squeeze in both bands, the currency pair prices are expected to make a large jump in either the downward or upward direction

  • If the existing market direction is towards, the prices are tended to drop even further, sending a sell signal to the traders
  • If the existing market direction is upwards, the prices are expected to increase sharply, sending a buy signal to the traders

Trade with Bollinger Bands to enhance your trading opportunities

Bollinger Bands provide you with accurate entry and exit signals in the Forex market. It tells you if the market is overbought or oversold, which you can use to either buy more of the currency pair or sell all of it together. With Blueberry Markets as your trading partner, you can learn more about the Bollinger Band trading strategies in both volatile and non-volatile markets.

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Guide to Forex
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