Bollinger Bands

Developed by John Bollinger in the 1980s, Bollinger Bands can be used to measure changes in supply and demand for the underlying currency pair.  

Bollinger Bands consist of three components:

• a middle band being a N-period simple moving average(SMA)
• an upper band at K times a N-period standard deviation above the middle band
• a lower band at K times a N-period standard deviation below the middle band

Standard values for N and K are 20 and 2

John Bollinger

Bollinger bands adjust themselves to the current market conditions. During periods of lower volatility, in sideways moving markets, the bands contract toward the moving average(middle band); during periods of high volatility, the distance between the two bands will widen and move further away for the middle band..



Mr. Bollinger notes the following characteristics of Bollinger Bands:

• Price breakouts tend to occur after the 2 bands (upper and lower) narrowed too far, as volatility lessens.
• When prices move outside the bands, a continuation of the current trend is implied.
• Price bottoms and tops made outside the bollinger bands followed by bottoms and tops made inside the bands call for possible trend reversals.
• A move that originates at one band tends to go all the way to the other band. This observation is useful when projecting price targets.

Formulas

Middle Band = 20MA (Moving Average)






Popular Trading Signals from Bollinger Bands

1. When the bands are contracting (due to decrease of volatility), look for price breakouts because the market is about to trend.
2. In a trending market, a price move outside the upper - or lower band indicates that the current up - or down trend is likely to continue.
3. In a ranging market, when price is close near the lower band, look for BUY opportunities since the currency pair is oversold, similarly, look for SELL opportunities when price is close near the upper band.



Summary

Bollinger Bands serve two primary functions when trading forex:

• To identify periods of low volatility in the currency market.
  ==> Look possible for breakouts.
• To identify periods when currency prices are at extreme, and possibly unsustainable, levels.
  ==> Look for possible pull backs.