Understanding Bollinger bands in forex trading

Foreign Exchange (Forex) Definition

Bollinger bands are technical analysis tools developed by John Bollinger in the 1980s. They are used to measure market volatility and identify potential trading opportunities.

Bollinger bands are comprised of two lines: an upper line and a lower line, marked two standard deviations away from an SMA, representing the Bollinger band’s middle line.

The distance between the upper and lower lines is what Bollinger referred to as the ‘bandwidth’. The wider the bandwidth, the greater the market volatility. The narrower the bandwidth, the less volatile the market.

When market prices break out above or below the Bollinger bands, it is considered a signal that the market will become more volatile.

How can you use Bollinger bands in forex trading in the UK?

Identify the Bollinger bands on your forex chart

The first step is to identify the Bollinger band lines on your chart. These are usually two standard deviations away from a simple moving average (SMA).

Look for the market price to break out of the Bollinger bands

Once you have identified the Bollinger bands, you should look for the market price to break out above or below these levels. It is considered a signal that the market is about to become more volatile.

Enter a trade in the direction of the breakout

If you see a market price breakout above the upper Bollinger band, you will enter a long (buy) trade. If you see a market price breakout below the lower Bollinger band, you will enter a short (sell) trade.

Place your stop-loss order

Once you have entered your trade, you should place your stop-loss order at the opposite Bollinger band. So, if you bought the market, your will place your stop-loss below the lower Bollinger band. In contrast, you would place your stop-loss above the upper Bollinger band if you sold the market.

Take profit when the market price hits the opposite Bollinger band

You should set your take profit target at the opposite Bollinger band to your entry point. So, if you bought the market and it broke out above the upper Bollinger band, your take profit target would be below the lower Bollinger band. If you sold the market and it broke out below the lower Bollinger band, your take profit target would be above the upper Bollinger band.

Benefits of using Bollinger bands

They are easy to use and understand

Bollinger bands are easy to use and understand., making them an excellent tool for beginners and experienced traders.

They can help you manage your risk

Bollinger bands can also help you manage your risk because you can place your stop-loss orders at the opposite Bollinger band to your entry point. It will help you limit your losses if the market turns against you.

They can help you identify potential trading opportunities

Bollinger bands can also help you identify potential trading opportunities because they can help you spot market price breakouts. These breakouts usually occur before the start of a new trend.

They are popular and widely used

Bollinger bands are also popular and widely used, meaning ample information and resources are available on them.

Disadvantages of using Bollinger bands

They are a lagging indicator

Bollinger bands are a lagging indicator, meaning they will only tell you what has happened in the past, not what will happen in the future.

They can give false signals

Bollinger bands can also give false signals because market prices often move in a zig-zag pattern. They can break out above or below the Bollinger bands but quickly return inside them.

They can be subject to interpretation

Bollinger bands can also be subject to interpretation because it is up to the trader to decide whether a market price breakout above or below the Bollinger bands is significant or not.

They do not consider the fundamentals

Bollinger bands also do not consider the fundamentals, such as market news, political landscape, and the economic health of a country. Especially in forex trading, they should not be used as the sole basis for your trading decisions.

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