Trading With Bollinger Bands

Bollinger bands are another well used trading indicator. The bands come in pairs and represent the upper and lower trading range of a particular market.  The bands are shown on either side of a moving average to help traders find potential entry and exit levels on forex trades.  The lines will represent the predicted range either side of the moving average. Introduced in the 1980’s by John Bollinger the bands predict standard deviation.

Bollinger bands can be particularly useful trading tools for anticipating short or long term direction changes. The bands can be overlaid on any time frame of chart. Using the VantageFX charting package, simply go to Chart, Insert, then Indicators then Trend and click on Bollinger band. After clicking OK , the lines will be illustrated on the chart as shown below with the green lines.

The example above illustrates the two outer bands with a further middle green band as the neutral.

The example above illustrates the two outer bands with a further middle green band as the neutral.  As a general rule when the price reaches either of the outer bands (higher or lower) there is a high probability of a directional change and the price action should reverse to then move towards and touch the opposite band. If the band line is broken then the band will widen accordingly and the trend continue. This is shown in the early price action of the illustration. It should be remembered that this trading tool is often used in conjunction with other indicators to increase the probability of success and is based on historical price action.

Key features of Bollinger Bands:

1. A move originating at one band tends to go all the way to the other band.
2. Sharp moves tend to happen when the bands contract and tighten towards the average, when the price is less volatile. The longer the period of less volatility then the higher the propensity for a breakout of the bands.
3. When there is a breakout of the band, then the current trend is usually maintained.
4. A top or a bottom outside the band that is followed by a top or a bottom inside the band indicates a trend reversal.

Bollinger squeeze.

The Bollinger squeeze is a recognised condition (non medical) and indicates a period or either high or low volatility or consolidation. Trading the squeeze is looking for the breakout from the Bollinger bands in a similar way to trading trend line breaks. (Click here for trading using trendlines tutorial). The breakout will cause the Bollinger bands to diverge or move further apart.

The potential risk is the inability to pin point an exact entry or exit level, which is when traders should include using other indicators. Even Bollinger himself acknowledged “tags of the bands are just that – tags, not signals. A tag of the upper Bollinger band is not in and of itself a sell signal. A tag of the lower Bollinger band is not in and of itself a buy signal”. Price often can and does “walk the band”.

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