Bollinger Bands

To increase the probability of successful trades, traders must understand whether the market is in TREND or RANGE. Common technical indicators that can help traders delineate between the two different market conditions include Bollinger Bands and ADX.

Basically, Bollinger Bands plot standard deviations above and below a moving average. They were developed in the early 1980s by John Bollinger and are typically used to determine volatility. However, we like to use Bollinger Bands to help us gauge trends. In the chart on the right, we plotted a standard Bollinger Band using the settings 20,2 (which mean 2 standard deviations away from the 20-day moving average) and then added a set of 20,1 (1 standard deviation away from the 20-day moving average). This helps us to create our “Buy Zone” and “Sell Zone”.

Typically when an uptrend in a currency pair is very strong, it will remain in the “Buy Zone” (the zone between the Upper Bollinger Band of 2 Standard Deviations and the Upper Bollinger Band of 1 Standard Deviation) for some time and typically when the downtrend is very strong, the currency pair will remain within in the “Sell Zone” ( the zone between the Lower Bollinger Band of 2 Standard Deviations and the Lower Bollinger Band of 1 Standard Deviation). If the currency pair closes below the buy zone or above the sell zone, we say that it has entered the “Range Trading Zone.”

Note: Typically when an uptrend in a currency pair is very strong, it will remain in the “Buy Zone” for some time and typically when the downtrend is very strong, the currency pair will remain within in the “Sell Zone”.

Bollinger Bands are great tools to use to help determine when market enters or exits a trend. For those traders who like to pick tops and bottoms, a good way to do so is to wait for the currency pair to exit the buy or sell zones.

Material published courtesy of GFT