If you are a forex trader and don’t use Bollinger Bands then you should as they are one of the simplest and most useful tools you can use to make bigger profits in your forex trading strategy. Here we will take a look at exactly what they are and 3 ways you can use them to increase your forex earnings.
Definition
Developed by John Bollinger, it is one of the most popular, flexible, and easy-to-use technical indicators out there. Here we will look at the logic behind them and how to use them to enjoy higher forex profits.
Bollinger bands are simply volatility bands one on either side of a simple moving average. They are calculated using the standard deviation of the price over the same period as the moving averages and are plotted on either side of the moving average. Moving averages are used to identify the underlying trend and bands combine this with the ability to view individual currency volatility as a trading envelope.
The distance between the upper and lower bands reflects the standard deviation of the price (volatility) of the traded currency. As prices become more volatile, the outer bands move further away from the long-term average, while volatility decreases, of course, moving closer to the moving average.
Why is it so useful
In any market, its value tends to increase slowly over time, but prices rise from time to time and are usually a reflection of the greed or fear of the participants.
Short-term price spikes never last long, and prices eventually return to more realistic levels: the mid-band or long-term moving average. Therefore, the volatility of the outer bands tells us how volatile prices are and how far prices have moved from fair value.
Here are three ways to increase your earnings with them:
1. Catch new trends
When a market is consolidating it tends to exhibit low volatility, when it is trending, on the other hand, there is usually higher volatility.
When the outer and inner bands are narrow, this shows a market with low volatility; however, low volatility in currencies never lasts long and traders can be alert for a breakout and a new trend. The trader should look for prices breaking out of the outer bands in either direction to indicate a potential new trend.
2. Timing of your trading signal
If you want to enter an existing trend, Bollinger Bands can help you determine the best area to execute your trading signal in terms of risk to reward. In a strong trend, prices will tend to drop to the middle band or fair value and this is the place to execute your trading signal.
Look at any strong trending coin and you will see how effective this simple strategy is.
3. Detect market tops and bottoms
When the top of the band is reached you can sell, prices should return to the moving average. If the price touches the bottom of the band, they again look for prices to return to the average.
DO NOT USE IN ISOLATION!
The above is simply an indicator of volatility – they should NOT be used in isolation to input trading signals.
When using them, they should be combined with support and resistance lines on your forex charts, and ideally, before entering a position, you should use momentum oscillators to confirm your move. An ideal one is stochastic (although there are many more), if you confirm each setup you will have the odds on your side and that means big wins in the long run.
Bollinger Bands are a great tool and if you want to trade more profitably make them part of your forex education.