Bollinger bands indicator is one of the most widely used indicators in the currency market. It is very useful instrument as it can be used both as an independent instrument and as a confirmation of the main signals from the other instruments of the technical analysis.
Brief information about the indicator
Bollinger bands consists of three lines: moving average with the period 20 and two other lines, which are deviated from the simple moving average for the value of the “market noise”- average deviation. The settings of the moving average line and deviations can be changed in the settings program. However, a creator of the indicator was sure that default setting was optimal at all time intervals and it was not necessary to change the settings.
Methods of operation with the use of Bollinger Bands recommended by the creator of the indicator
John Bollinger, the creator of the indicator recommended to apply the indicator at the option of a trader, but keeping in mind that the indicator was created as a supplement to the graphical analysis. First of all, it can confirm the reversal of such patterns as “head and shoulder” and “double bottom”. A method of operation is described on the example with the pattern “head and shoulder”.
- Search large trends on the daily chart.
- Left shoulder and a head should go above the upper band of the indicator (if uptrend is reversing to the downtrend).
- The right shoulder shall not touch the upper band of the indicator.
- A signal for the entry comes much late after the formation of the pattern. That is why, Bollinger advises to turn to the chart with the shorter time-frame soon after the formation of the right shoulder, and enter the market after receiving a confirmation of the trend reversal.
The strength of the trend is confirmed if the price systematically exceeds the upper band (in case of uptrend) or the lower band (in case of downtrend). If the price returns to the channel and then breaks out the moving average line, we can assume that the trend will reverse, or the pair will undergo deep correction.
Bollinger Bands as a main indicator in the trading system
In most cases the price moves as a wave. Bollinger bands makes a channel within which the price spends up to 80-90% of its time, rebounding from the upper or lower limits of the channel. There are cases when the price rebounds from the moving average line. By adding Oscillator to the Bollinger bands we will receive a trading system, enabling to track minor price movements.
- When the price approaches the upper/lower limit of the indicator it is necessary to wait until the Oscillator gives confirmation of the formation of the local lows/highs.
- After the formation of the signal a trader can open a positions and place stop-loss either above or below the extremum.
- The potential profit will be first at the level at the middle line and then will move towards the opposite to the entry line.
Strategy based on the optimized Bollinger Bands indicator
Some authors suggest to optimize parameters of Bollinger Bands As follows:
- Moving average with the period 55 is not marked on the chart but is used for calculating external lines;
- The value of the average deviation is multiplied by a coefficient of 0.2 instead of standard 2;
- The area between the lines is colored blue.
The authors of this strategy suggest to treat this indicator as a “river,” which the price is going to cross. For example, in case the downtrend is changing to the uptrend, the following conditions should be observed:
- On the left bank of the river a “dry” candlestick should be formed: a candlestick should appear above Bollinger Bands and the extremums of this candlestick should not touch the indicator.
- Limit order to buy is placed at the highs of the first “dry” candlestick.
- Stop loss shall be placed below the lower band of the indicator.
- Take profit is placed at the equal distance from the entry price to the stop-loss.
The authors recommend to apply this strategy for the main currency pairs on the 15M time-frame.
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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.