Bollinger bands came from a market technician known as John Bollinger. He developed an analytical technique that made use of three bands within a chart. These are the moving average band that has both an upper trading band and a lower trading band called price channels. Bollinger bands subtract and add calculations based on a standard deviation. It is a technique in diagnosing reversals and trends in the foreign exchange market.
A standard deviation is the measurement of a set of data that has dispersed from its average. The further the data disperse from the average, the higher its standard deviation is. Standard deviation measures the historical volatility of a market instrument. It is measured across periods of time to get an investment’s volatility. This will show traders the possibility of how an asset’s price can differ when compared to its true value.
A moving average is a technical analysis indicator that shows a security price’s average value within a set time frame. It is frequently used in measuring momentum and defining areas with possible resistance and support. This type of indicator is used in charting the directions trends are moving to. It can track continuing trends as well as paused trends. Bollinger bands are good for traders who prefer conducting business with a visual representation in measuring the volatility of prices. Trading Platforms is another way through which traders to assess market conditions and make the necessary adjustments to their trades.
In Bollinger Bands, the moving average is the centerline with an upper band that is typically two standard deviations higher than the moving average and a lower band that is also two standard deviations lower than the moving average. In the foreign exchange market, Bollinger bands will have a default value of (20, 2). The standard deviations that are studied are usually set on a 20-day average. In this setup, the moving average will usually have greater gravity on the data that is most recent. It also reacts more quickly to recent changes in price. The volatility in an asset’s price is seen in the way the bands expand or contract. If the bands expand, the price becomes more volatile. If the band’s contract, it means the market has slowed down and the price becomes bound in a tight pattern. Most traders tend to sell the moment the price hits the upper band, and they buy when the price hits the lower band.
Reading Bollinger Bands and Their Patterns
- Price Uptrend and Downtrend
Traders have to identify price movements and determine whether the prices form an uptrend or a downtrend. Bollinger bands in a chart will normally have prices that concentrate in a certain area. An uptrend occurs when prices predominantly stay above the moving average. A downtrend happens when prices stay below the moving average.
- Low Volatility and High Volatility
Bollinger bands help traders determine volatility breakouts. Low volatility is usually seen as a signal that there will be a high volatility breakout. Data following a narrow path that almost parallel signifies low volatility that traders presume will increase when the market experiences a breakout. A breakout happens when prices go either above the upper trade band or below the lower trade band.
- Trend Continuation and Trend Reversal
Bollinger bands also let traders know if there is a continuation in the trend. This happens when the price closes above the Bollinger upper band or below the Bollinger lower band. The trend continues and volatility increases while the Bollinger bands begin to widen. This will usually imply that prices have been exhausted, and there will be a reversal in the trend. Trend reversals are more common than trend continuations because prices do not usually keep a steady narrow trend for long periods of time.
- Bollinger Bands M and W Patterns
An M pattern is also called a double top pattern. It happens when the price touches the lower trading band, moves upward toward the moving average, and falls back down again. The second low is higher than the first low and does not touch the lower trading band. It forms a letter M. The W pattern is also known as the double bottom pattern. It is the exact opposite of the double top pattern. There are two highs instead of two lows. Traders confirm the patterns when they continue and cross the moving average.
Trading with Bollinger Bands
- Playing the Bands
Trading using Bollinger bands is based on the concept that closing prices should be kept between the bands. Even if prices go higher or lower than the trade bands, it should be presumed that these prices will turn back to the space between the Bollinger bands closer to the moving average. The instances where the prices deviate over the bands are the signals traders usually wait for to either buy or sell in the foreign exchange market.
A buy signal happens when the price falls below the lower Bollinger band. This is when the price is at its lowest in the market period. Predicting the subsequent rise in price will mean the trader’s purchase was advantageous. Their sell signal is when the price rises above the upper Bollinger band. This is when the price is highest during the market period. Speculating that the trend will drop right after will mean the trader’s sale was profitable.
- Playing the Band Breakouts
Traders using this trading method do the opposite of what is done when playing the Bollinger bands. Traders buy when the price breaks out above the upper trading band, and they sell when the price breaks out below the lower trading band. These traders usually bet on reversions to be able to gain profit.
- Volatility Strategies
There are options traders can buy when applying volatility strategies. Traders can buy options that have low volatility if they think that volatility will increase. If it does increase, they can sell it at a more expensive price. Prices cannot stay at low volatility for long periods of time, so traders can use that opportunity to buy the options while they are still