Forex Trading Indicators: Applying Bollinger Bands, A Vital Device For Technical Forex Traders

Bollinger bands on forex trading charts are used just as on equities and options trading charts, as an indicator to make the trader aware of a new unfolding movement, breakout or trend. They are made up of three lines or bands.

The central band is a simple moving average over a specific number of intervals, normally 20. The upper and lower lines are at a fixed number (usually 2) of standard deviations calculated referring to the number of intervals used for the center band.

Bollinger bands were discovered by John Bollinger in the 1980s. The rationale behind them is that prices will generally alternate within 2 standard deviations of the median, which here is the moving average used to plot the middle line. This implies that as prices reach the upper and lower band lines, a reversal is likely to maintain the prices within the bands.

They are also an indicator of fluctuation. Wider bands show signs of a more volatile market than narrow bands.

Traders use Bollinger bands in several different ways but these are the two most widespread ones:

1. Pinpointing of overbought and oversold market conditions

On the basis that prices are seeming to move within the bands, numerous traders will use Bollinger bands as an indicator to sell when the price rises above the upper line and buy when it slides below the lower line. Normally they will plan to close their transaction when the price nears to the central line.

Alertness is essential here, however, as these movements outside of the bands could just signal a powerful trend forming in that direction. So you could be stuck on the false side of a powerful price movements in some cases. John Bollinger himself recommended all the time examining against different indicator. Presumably the most suitable for this function are non-oscillating indicators such as trend lines or chart formations.

2. Identification of contraction and forecasting breakout

As we have seen, the bands will diverge and converge consistent with the volatility of the market over the calculated past intervals. When they converge so that their area becomes narrow, this is called contraction. Some traders will act assuming that contracting bands is a signal of a powerful breakout and place both buy and sell orders outside the bands.

The risk here is that there can frequently be a misleading move where the prices will stretch outside the bands shortly prior to turning. Because of this reason some traders prefer not to act on the first move outside the bands. Again you should always check against another indicator on your forex charts, or use forex signals as a checking tool. A forex signal is a market forecast and a trading recommendation, which can be used as a confirmation, especially if comes from a reliable forex signal provider.

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