Using Bollinger Bands (Part I)
As forex traders, we rely on currency markets volatility as a means to make profits. We can only make profit when the currency pairs price moves up and down and changes. If it does not change, there are no pips to be made. When the market produces a consistent, repeatable move up or down, we want to make pips from that change in the price level.
What is volatility? Volatility is the relative rate over a period of time at which the price of a currency pair moves up and down in the market. In more simple terms, it is the amount of price change measured over a period of time. Suppose over a short period of time, the currency pair price moves up and down rapidly. The currency market is showing high volatility. On the other hand, the markets are showing lower volatility if over a time period, the price does not move much.
If you are in currency trading, you should know that currency markets are either ranging or trending. Markets are usually ranging 80% of the time. In a range bound situation, the bulls and bears are in constant battle. But neither side is winning the battle. Like a long rally in a tennis match, price action is back and forth, back and forth.
When range bound, the market established a fairly consistent level of volatility. We would like to know where the market will reverse from up or down. Suddenly volatility increases and the market deviates from its range bound condition. When such a break occurs we would like to have an early warning that the move above and below the recent range is a significant deviation from the norm.
Bollinger bands estimate based on markets recent level of volatility, the probable high and low price of a currency air. The bands are drawn at an equal distance above and below a simple moving average (SMA).
Think of Bollinger bands as an envelope indicator that is projecting top and bottom lines around price. The stronger the bands are, the longer the time frame you are in. These bands act as mini support and resistance levels (S&R).
Bollinger bands are self adjusting. Bollinger Bands expand, open up and move in the opposite direction when the market becomes more volatile. The bands respond by contracting and becoming closer together when the market moves into tighter prices. In a range bound market, the bands are almost parallel.
John Bollinger was a famous technician of the markets in his days. Bollinger Bands were first introduced by John Bollinger in 1960s. There are three ways you can use Bollinger Bands in your trading. These are: 1) Range Trading. 2) Breakout Trading. 3) Tunnel Trading. You should now read Part II of the Bollinger Band article.