What are Bollinger Bands?

Pushed by his feeling that there should be a relationship between currency's price movement and bands, John Bollinger invented the Bollinger Bands. He considered that this relationship is more relevant than the one between bands and fixed percentage amount.

Bollinger Bands include the assumption that 95% of the price movement is included in two bands. Thus, the calculations consist of two standard deviations speaking in statistical terms. This estimation component provides bands with the adjustment possibility to any changes that can occur on the forex market.

Three curves form the Bollinger Bands. Usually the simple moving average is used in order to draw the middle one and it serves as the base for the upper and lower bands which are plotted at two standard deviations. The exponential moving average is sometimes used in plotting in order to provide for a higher sensitivity of the indicator. This, however, provides for the greater market noise as well.

Bollinger Bands Forex Market Application

One of the applications of the Bollinger Bands is the detection of unsustainable movements in prices, which are more extreme in their nature. Another application is connected with the discovery of any changes that have occurred in currency price trends.

Traders can apply the Bollinger Bands in order to identify support or resistance levels and contractions or expansions in price volatility that may occur.

Interpreting the Bollinger Bands

There are several ways in which traders can interpret the Bollinger Bands. One of them includes the occurrence of the price above or below the upper or lower band. In such a case, the trader may analyze this as a potential breakout and respond to it by taking a position that is synchronized with the breakout.

Bollinger bands can also be used as an indicator of a currency pair that have been overbought or oversold. A currency pair can be regarded as being overbought if it touches the top of the band. Traders will interpret this event as the possibility of the currency pair returning to its mean or middle moving average band and thus, they will attempt to sell it.

On the other hand, a currency pair is considered oversold, when it touches the bottom of the band. Traders will expect that the currency pair will increase back to the top of the band and aim to purchase it.

A straight relationship between volatility and the width of bands exists. For example, if high volatility is experienced, then the band will be wide and the vice versa.

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