Bollinger Bands

The Bollinger bands were first developed by John Bollinger, an American financial analyst, who helped contribute to forex technical analysis. If you are ever looking for more information on this indicator, John Bollinger also wrote a book called Bollinger on Bollinger Bands. In that book he details everything you could ever need to know about this trading indicator.

The Bollinger bands technique involves overlaying three lines or bands on top of a candlestick chart of the underlying security. The central band is a simple moving average of the daily closes using a moving average index selected by the trader. The upper and lower bands are running standard deviation above and below the central moving average. It is actually a pretty simple concept.

With the standard deviation being a measure of volatility, the bands become self-adjusting, widening during an unstable markets and contracting during calmer markets. If you are looking at short-term trading, Bollinger recommends 10 days, 20 days for intermediate and 50 days when it comes to longer-term trading.

The way that this indicator works is with two trader-selected input variables. These two variables are the number of days in the moving average index and the number of standard deviations to plot above and below the moving average.

More than 95 percent of all closes on a daily bases fall within three standard deviations from the average of that time period. When it comes to a typical market, values usually tend to fall in a range from 1.5 to 2.5 standard deviations. This is a trading indicator that you will want to utilize in your own trading as you begin to better understand it.

Characteristics of Bollinger Bands

The common thought of Bollinger bands is that prices tend to stay within the upper and lower band. The thing that sets the Bollinger bands apart from other charts is that spacing between the bands changes based on the movement of prices. Periods of crazy price changes, bands widen and become much more forgiving and during stable pricing markets, bands narrow.

When reading through Bollinger’s own book on his indicator, he presents to us the following traits of his Bollinger bands:

  • Sharp price changes tend to occur after the bands tighten, as volatility lessens.
  • When prices move outside the bands, a continuation of the current trend is implied.
  • Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend.
  • A move that originates at one band tends to go all the way to the other band. This observation can be very useful for projecting price targets.

Use Bands With Other Indicators

When using the Bollinger bands, you want to remember that they don’t need to be used solely for the purpose of generating buy and sell signals. You want to use them with another indicator and most of the time it will be the relative strength. What this does for a trader is to help them recognize when price touches one of the bands. This could mean a continuation of the trend or a reaction the opposite way.

By using the Bollinger bands with other indicators, it will be much more beneficial to your forex trading. Used by themselves, they do not provide everything you may need to know, which in the end comes down to figuring out when to buy and when to sell.