Forex Lesson 4: Bollinger Bands
Bollinger Bands are another method of interpreting and analysing market activity. Bollinger Bands are lines that trace the points of resistance and support .The area in between the Bollinger Bands reflects the market activity. If the market is range bound the bands will be narrow and compressed reflecting little fluctuation in the market. If the market is trending the bands will be undulating, with the area in between expanding or contracting according to the direction of the market activity.
Bollinger bands can be used with candlesticks to predict whether the price of a currency will go long or go short If a candlestick reaches the top of a Bollinger Band in a range bound market a fair assumption to make is that the trade will then go short, similarly if the candlestick reaches the bottom of a Bollinger band it is safe to assume that the trade will then go long. However it is important to remember when working with narrow margins, such as a range bound market it is more difficult to predict changes than in a trending market.
When looking at a trending market the Bollinger bands will undulate to reflect new currency prices. Often the bands will dip, then return to the same point then dip again a bit like a roller coaster, sometimes when this happens we can see two peaks of resistance with a dip in between. If a candlestick broke through these peaks of resistance and traded above the Bollinger band it would indicate that the currency pair is going long. If the candlestick did the opposite and traded below the bottom most points of the roller-coaster shaped Bollinger bands it would indicate that a currency pair was going short.
Candlesticks reflecting the currency pairs fall within the lines of the Bollinger bands approximately 95% of the time. Occasionally candlesticks may appear outside of the bands. When the candlesticks do fall outside of the bands it is an indication of extreme activities in the market and a possibility that the current trend may change. Candlesticks are most likely to fall outside the Bollinger Bands when the market is range bound but can occasionally occur in a trending market as described earlier in this module. When the area between the bands is greater there is less likelihood of the candlesticks falling outside of the bands. When looking for a possible change in a market look for narrow, compressed bands in a range bound market, as these bands then start to widen or expand a change in the market is signified.
It is important to remember that Bollinger Bands like all methods of interpreting market activity are not infallible. Sometimes a candlestick may break the Bollinger band and rise above the resistance point, indicating a market that is going long, but then suddenly plummet and go short instead. The best way to avoid being caught by the possibility of this is to use stop orders as mentioned in module one of this course. To ensure profit is locked in and you are not caught out by a suddenly falling market it is a possibility to initiate a sell order at the same point as your stop order, changing your trade from a long trade to a short trade.
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