Bollinger Band Trading the Forex
John Bollinger invented Bollinger Bands in the 1980s as a technical analysis tool for trading stocks, bonds, mutual funds, commodities and Forex. There are many different uses for Bollinger Bands, but the primary ways are to measure volatility of the current price action and to measure the highness or lowness of the price relative to previous trades.
Bollinger Bands consists of three lines:
1. a middle band being an N-period simple moving average
2. an upper band at K times an N-period standard deviation above the middle band
3. a lower band at K times an N-period standard deviation below the middle band
The values can vary but the typical values for N and K are 20 and 2, respectively. The choice for the average can be a simple moving average or an Exponential moving average. The same period is used for both the middle band and the calculation of standard deviation.
There are two indicators derived from Bollinger Bands, %b and BandWidth.
%b, pronounced 'percent b', is derived from the formula for Stochastics and tells you where you are in relation to the bands. %b equals 1 at the upper band and 0 at the lower band.
%b = (last - lowerBB) / (upperBB - lowerBB)
BandWidth tells you how wide the Bollinger Bands are on a normalized basis.
BandWidth = (upperBB - lowerBB) / middleBB
Using the default parameters of a 20-period look back and plus/minus two standard deviations, BandWidth is equal to four times the 20-period coefficient of variation.
Uses for %b include system building and pattern recognition. Uses for BandWidth include identification of opportunities arising from relative extremes in volatility and trend identification.
The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition, prices are high at the upper band and low at the lower band.
The few uses of Bollinger Bands follow below:
- Buy when price touches the lower Bollinger Band.
- Exit when price touches the moving average in the center of the bands.
- Buy when price breaks above the upper Bollinger Band
- Sell when price falls below the lower Bollinger Band.
- Options traders, most notably implied volatility traders, Sell options when Bollinger Bands are historically far apart
- Option traders, Buy options when the Bollinger Bands are historically close together
- When the bands lie close together, a period of low volatility in price is indicated.
- When they are far apart a period of high volatility in price is indicated.
- When the bands have only a slight slope and lie approximately parallel for an extended time the price of a price will be found to oscillate up and down between the bands as though in a channel.
Bollinger Bands will often be coupled with a non-oscillator indicator like chart patterns or a trendline and if these indicators confirm the recommendation of the Bollinger Bands, the trader will have greater evidence that what the Bands forecast is correct.