What are Bollinger Bands - How to use in Forex Market

Bollinger Bands are an advanced form of trading band developed by John Bollinger and used by traders worldwide. But, like any other forex indicator, they only provide a framework, NOT absolute BUY and SELL signals. All trading bands exist for a single purpose, to answer the question "Are prices relatively high or low?". That bit of information is incredibly valuable and even more powerful if combined with indicators that depict where the price is in relation to the bands and how wide the bands were, along with supply/demand tools.

What are Bollinger Bands

The Bollinger Bands are trading bands that focus on volatility. By allowing the movement of prices themselves to set the width of the bands, John Bollinger's Bollinger Bands are able to react quickly to market conditions.

Bollinger Bands (BBs) are a simple yet powerful combination of channels and Moving Averages (MAs). BBs consist of a Simple Moving Average (SMA) surrounded by an upper and lower band plotted by a certain number of standard deviations above and below the SMA. Think of them as flexible channels whose width varies with price volatility. The wider the price swings over the period of the SMA, the wider the channel; the narrower the price range over this period, the narrower the channel.

The default settings on most charting software will be a 20-period SMA with the bands at a distance of two standard deviations (discussed next) from this SMA. The figure below shows what they look like using these “20, 2” default settings.

You can change these settings to suit your needs, and later we’ll look at one useful variation and probably the most accurate forex indicator: Double Bollinger Bands (DBBs). However, the standard settings are popular and are worth watching for the sake of knowing what the herd is seeing as potential s/r from the lower and upper bands.

Continue reading for more information or start playing around in a ​risk-free demo account and learn how to read Bollinger Bands in real-time without risk or financial obligations.

How to use Bollinger Bands

The two standard deviation width of the channel means that the statistical probability of price hitting the bands given the price range of the past 20 periods is only about 5 percent. However, like any statistical measure, it assumes that all elements of the sample, in this case, the 20 periods, are the same.

That assumption works for flat, range-bound markets or gently trending markets, which by definition are times when no change occurs in the markets’ perception of a currency pair’s value. Under those conditions, the upper and lower bands provide reliable s/r points. In flat or mild trends, the price tends to fluctuate between the upper and lower bands, as price bounces off the upper and lower bands like a ball bouncing off the floor and ceiling. Even if price swings widen or narrow, Bollinger bands adjust for those conditions and widen or narrow with the price swings, providing support/resistance (s/r) points that adjust with volatility (a uniquely valuable feature of BBs). In Figure above, price usually bounces off these bands back toward the middle, particularly when price makes a sudden sharp move up or down. 

Using the standard default settings of a 20-period SMA middle band with each band two standard deviations distance from the middle band, there is only a 5 percent chance that the price will ever touch the outer bands. Again, this calculation assumes (as with any statistical measure) that all sample elements (the past 20 periods) were the same and all prices equally probable. When there’s no strong trend or no trend at all, that assumption applies. Flat price action suggests that market perceptions about the value of a currency pair haven’t materially changed.

However, that assumption doesn’t apply in a strong trend, which by definition indicates market perceptions about value are changing.

Bollinger Bands Don’t Provide Meaningful S/R with Strong Trends

BBs are useful s/r points only when the pair (or any other asset) is in a flat trading range, as in the Figure above, where you can see how price tended to bounce off the upper and lower bands. However, if a currency pair or any other asset is in a clear trend, you won’t see that tendency for price to bounce off these bands. If the trend is strong, as in Figure below, the bands provide no useful s/r at all as the price can climb up or down the BBs for long periods repeatedly. The price continued to climb the upper band from April to mid-June 2010, September to October 2010, February to April 2011, and July 2011 (all periods highlighted).

You don’t need to know why this is true, but just in case you’re interested, here’s a basic layman’s explanation.

Assuming the two standard settings mentioned previously, then statistically speaking, 95 percent of the 20 closing prices were supposed to fall within two standard deviations from the middle band. However, as noted, statistics assume that all data or elements of the sample (in this case, the past 20 closing prices for each candlestick) are equally probable. That’s not the case for strongly trending markets, which by their nature indicate that perceptions of value are changing. So, the 20 (or other) past 20 data points or closing prices were not equally probable. For example, during a rising trend, higher prices are more likely than lower ones. Changing perceptions of value mean that the latest prices have a higher probability of hitting the upper band in an uptrend or lower band in a downtrend.

In sum, strongly trending markets reflect a change in how the asset’s value is perceived, so the Bollinger Bands indicator doesn’t work as meaningful support or resistance in strongly trending markets.

However, BBs have additional uses besides gauging s/r in flat or gently trending markets. 

Bollinger Bands Strategy - The Brilliant Extension

While standard single Bollinger Bands can provide a degree of support or resistance (s/r) in flat or gently trending markets, Bollinger Bands don’t provide reliable support and resistance in strongly trending markets, because they widen with increasing volatility, so a strong trend can continue to climb the upper or lower band for extended periods.

There’s lots of material written about standard single Bollinger Bands, so we’ll focus on their newer, less covered but far more useful variant, the Bollinger Bands strategy named Double Bollinger Bands.

In addition to the standard bands set at two standard deviations’ distance from a 20-period simple moving average (SMA) at the center, add a second set of bands only one standard deviation away from that SMA.

By using Double Bollinger Bands (DBBs), probably the most accurate forex indicator, we get a much better indication of:

  • Whether a trend is strong enough to continue riding or to enter new positions even if it has been going on for a long time.
  • Whether it’s time to take profits or to get ready to trade the reversal.

Setting up Bollinger bands in MetaTrader 4/5

This section shows you how to set up Bollinger bands in MetaTrader 4/5. It assumes that you have opened a chart.

Add the Bollinger bands and set the parameters of this indicator

  1. Click Insert and move your mouse over Indicators and Trend
  2. Click Bollinger bands

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Setting the common parameters

After you have completed the step above, the settings menu appears.

Bollinger bands

Most indicators can be controlled by several common parameters.

There are two types of parameters:

  • Calculations of the indicator: e.g. the number of periods used for the Bollinger bands (you do not need to worry too much about this in the beginning)
  • Visuals of an indicator: e.g. how it will look, the color and thickness of the lines, etc.

Bollinger bands

Changing parameters at a later time

To change the settings of the indicator directly on the chart at a later date:

  1. Right-click the Bollinger bands (you will have to be exact on the line of the indicator to get the menu seen below)
  2. Choose Bands(20) Properties – The (20) is the respective parameter (Periods) and can differ, depending on your choice when setting the parameters.

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The parameter menu appears again where you can change the indicator.

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Deleting an indicator

To delete the Bollinger bands:

  1. Right-click the indicator that you want to delete (you will have to be exact on the line of the indicator to get the menu shown below).
  2. Click Delete Indicator.

Bollinger bands

The Bollinger bands disappear from your chart.

Understanding how to use Bollinger Bands is important, but if you want some help, sign-up and our trainers can provide you the right guidance. Start trading and notice how this Bollinger Bands extension can make you serious money today.

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Categories:  Forex