Unveiling the Secrets of Bollinger Bands Trading

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In forex trading, Bollinger Bands trading is a buzzword. This technical analysis tool, named after its creator, John Bollinger, is a favorite among traders for its versatility and efficacy. Let’s delve deeper into the world of Bollinger Band trading.

Understanding Bollinger Bands Trading

Understanding Bollinger Bands Trading

Understanding Bollinger Bands Trading

The Bollinger Bands indicator visually represents market volatility and price levels over a certain period. They consist of three lines, as shown in the CADCHF 4-hour chart above: a simple moving average (SMA) and two standard deviation lines plotted above and below the SMA.

The calculation for the indicator is as follows:

  • Middle Band = 20-day simple moving average (SMA)
  • Upper Band = 20-day SMA + (2 x 20-day standard deviation of price)
  • Lower Band = 20-day SMA – (2 x 20-day standard deviation of price)

Bollinger Bands trading serves multiple purposes, so please stay with us to learn the powerful aspects of this indicator with live examples.

Identifying Market Trends with Bollinger Bands

The widening bands indicate increased market volatility and potential for trend formation. Conversely, narrowing bands suggest decreased volatility and a likelihood of range-bound trading.

The USDCHF 4-hour chart below is an excellent example of identifying market trends using the indicator. As depicted in the screenshot, the indicator began to widen its band on April 10, and consequently, the market stepped up by breaking the 0.908 resistance.

Bollinger Bands: Identifying Market Trends

Identifying Market Trends

Bollinger Bands and Predicting Price Reversals

Sharp price changes often occur after the bands tighten due to decreased volatility. We explained what would happen in the market if the indicator widens its bands. But what if the bands narrow down? The USDJPY 4-hour chart below is another good example of when the indicator begins to narrow its bands.

Bollinger Bands: Identifying Market Trends

Bollinger Bands: Identifying Market Trends

The screenshot above shows that a narrow band represents a low-volatility market. The Standard Deviation indicator is also in line with the Bollinger bands, and its value dropped to 0.08 simultaneously, representing a sideway or low-volatile market.

It is worth noting that a range market might seem like a low-opportunity market. In fact, the trading instrument rests and awaits economic news from central banks before making a significant move. Therefore, by monitoring the bands and the support and resistance areas in a range market, traders and investors can join the market on break-outs.

Bollinger Bands: Identifying Market Trends

Bollinger Bands: Identifying Market Trends

The same USDJPY 4-hour chart above is an excellent example of trading breaking out in a sideways market condition.

Since March 20, 2024, the U.S. dollar has been suppressed between the 151.9 resistance and the 150.8 support against the Japanese yen. But the bulls crossed above 151.9 on April 10 with a long bullish candlestick, and consequently, the uptrend continued, and the bands began widening.

Spotting Overbought or Oversold Conditions With Bollinger Bands

When prices touch the upper band, it may indicate an overbought condition. Conversely, prices touching the lower band may suggest an oversold condition.

In the USDCHF 4-hour chart below, I have highlighted the price point that exceeded the Bollinger bands. As depicted, when the U.S. dollar’s value significantly increased against the Swiss Frank, the pair’s price was driven outside the bands. That is an overbought condition, which could lead to the market stepping into a consolidation phase or possibly reversing the trend.

Spotting Overbought or Oversold Conditions With Bollinger Bands

Spotting Overbought or Oversold Conditions With Bollinger Bands

Strategies for Bollinger Bands Trading

There are several strategies that traders can employ when using the Bollinger Bands trading method:

The Bollinger Bands Bounce Trading Strategy: This strategy is based on the concept that price tends to return to the middle of the bands. Traders buy when the price hits the lower band and sell when it touches the upper band.

The USDCHF chart below shows the Bollinger Bounce trading strategy. The price bounces or pulls back whenever it hits the upper or lower bands. Please be informed that trading the Bollinger Band solely is not recommended since it can’t filter false signals. Mixing this indicator with other technical tools is wise to spot the oversold and overbought market. The relative strength index (RSI) and the Envelopes indicator are good combinations with the Bollinger bands.

The Bollinger Bands Squeeze Trading Strategy

A squeeze happens when the bands close together, constricting the moving average. It signals a period of low market volatility and is considered by traders to be a potential sign of future increased volatility and possible trading opportunities.

The USDJPY analysis in this article shows how to trade squeezed or sideway markets using Bollinger bands.

Double Bollinger Bands Trading Strategy

This strategy uses two sets of Bollinger Bands with different standard deviations (1 and 2), which can help identify high or low volatility periods and potential buy and sell signals. This approach helps with finding support and resistance points, which is vital because the price always moves between levels, and once it breaks a level, it moves from one to another.

Double Bollinger Bands Trading Strategy

Double Bollinger Bands Trading Strategy

The USDHKD 4-hour chart above shows two sets of Bollinger bands on one chart. The bands in red represent deviation 2, and the blue bands, narrower than the red ones, have the deviation 1 setting (depicted in blue). The screenshot from the chart shows that the U.S. Dollar bounces against the Hong Kong Dollar when it peaks above the Bollinger bands in red. But, to determine if the price would dip, we examine the price behavior around the upper band of the blue line.

If the price closes and stabilizes below the bands with deviation 1 setting (in blue), it will likely extend its decline to the middle band, followed by the lower band. This trading strategy suits high-frequency traders who intend to exit trades quickly.

Final Thoughts

Bollinger Bands are a powerful tool in a trader’s arsenal, providing valuable insights into market conditions. However, they should not be used in isolation. They should be used with other indicators and tools to increase their effectiveness and accuracy. Remember, while Bollinger’s trading strategy can guide your decisions, they do not guarantee profits. Trading always carries risk.

  • 16 October 2023