What Are Bollinger Bands in Forex Trading?
A Bollinger Band is one of the trending terms that you cannot fail to recognize as an expert forex trader. The regular encounter may pressurize you to seek what it entails and whether it can benefit your Forex trading.
Developed by John Bollinger, Bollinger Bands are technical indicators, helping you determine overbought or oversold signals. In forex trading, the signals echo the currency pair price and volume.
Understanding Bollinger Bands means grasping concepts of technical analysis, simple moving averages, and trend lines. Besides, this article guides you in the calculation, advantages, and disadvantages of Bollinger Bands.
Read on to know how to boost your forex earnings from Bollinger Bands technical indicators.
The Root of Bollinger Bands
Bollinger Bands’ implementation’s motivation rose from the need to conduct adequate technical analysis in forex trading.
Besides fundamental and sentiment analysis, technical analysis is a core forex trading activity to let you determine when currency pair prices are likely to change. It involves the study of historical chart data.
Several technical indicators pioneer the success of technical analysis. The most typical technical indicators are:
- Stochastic oscillator.
- Moving average convergence divergence (MACD).
- Bollinger bands.
- Relative strength index (RSI).
- Fibonacci retracement.
- On balance volume (OBV).
- Ichimoku Kinko Hyo.
- Chaikin money flow.
- Klinger oscillator.
- Average directional index (ADX).
The essence of having a wealth of forex trading technical indicators is to curb the false signals you may encounter when you over-rely on a single technical analysis tool. And here is the more exciting part.
Most technical indicators attempt to improve their reliability by incorporating the concepts of other tools. The best example is the use of simple moving averages in Bollinger Bands.
Here is how the concepts merge to present you with a scalable, dependable forex trading technical analysis indicator.
The Composition of Bollinger Bands
Bollinger Bands constitute three lines. These are simple moving average lines, upper and lower bands.
Briefly, moving averages are technical indicators that forecast trends by getting periodic prices divided by the number of periods. It further subdivides into simple and exponential moving averages.
Here’s an example of calculating a simple moving average (SMA). Assume you record weekly highs of EURUSD as follows: 1.2124, 1.2200, 1.2196, 1.3032, and 1.3558.
The simple moving average would be (1.2124 + 1.2200 + 1.2196 + 1.3032 + 1.3558)/5 = 1.2622. The average differs for subsequent calculations since currency pair prices are dynamic.
In Bollinger Bands, the SMA is the middle line. The upper and lower lines express their positions relative to it.
The three lines unite to help you find volatility— the quantity of price projecting in a direction. This happens in the following ways:
Importance and Limitations of Bollinger Bands
- The tightening of the bands during low volatility symbolizes the probability of a sharp price moving in either direction.
- A large gap between the bands shows increasing volatility and echoes the current trend is about to end.
- The swinging of price between the upper and lower lines—also referred to as standard deviations—can help you spot potential profit targets.
- The divergence of the prices out of the bands signifies a continuation of a strong trend.
Conversely, one major weakness of Bollinger Bands is that they provide false signals in a trending market.
Here’s how to calculate Bollinger bands
Calculation of Bollinger Bands
Let’s assume you are working on a 20-day trading period. Calculate the SMA and standard deviations (of the upper and lower lines) for the twenty days. Next, use the following formula to calculate Bollinger bands.
BOLU = MA (TP, n) + m ∗ σ [TP, n]
BOLD = MA (TP, n) + m - σ [TP, n]
With each term symbolizing the following:
BOLU => Upper Bollinger Band.
BOLD => Lower Bollinger Band.
MA => Moving average.
TP => typical price that’s => (High + Low + Close) ÷ 3
n => Number of days in the period.
m => Number of standard deviations.
σ [TP, n] = > Standard Deviation for n periods of TP.
Now that you understand why, when, and how to use Bollinger Bands, go ahead and use it to boost your forex trading analysis for higher earnings.