Do you have an idea what is Bollinger Band Forex indicator? Have you ever wondered how to read Bollinger Bands? If yes, then you have come to the right place. This article will explain you the structure and the calculation of Bollinger Band as well as how to read Bollinger Bands signals.
What is Bollinger Band Indicator
A long-term technical analyst, John Bollinger, in 1980s, developed a method which refers to what is Bollinger Band Forex indicator today. He was using 2 trading levels one above and other below the moving average. It simply involved addition or deletion to the moving average instead of percentage variation to it, like other indicators. This instrument was named after his name as Bollinger Bands Indicator.
Structure of Bollinger Bands
Before studying how to read Bollinger Bands, we would first need to examine its structure.
Bollinger Bands involve two price levels (bands), one above and other below the exponential moving average. These bands are actually standard deviations from the exponential moving average and may contract and expand depending upon the price volatility of the currency pair under study.
Bollinger Bands Calculation: How to Calculate Bollinger Bands
Now that we got familiar with its structure, we will switch to how to calculate Bollinger Bands.
The standard deviation is a statistical Bollinger Bands calculation that calculates the sum of the square of differences from the between the closing price and moving average for each of 20 days. For example for calculating 3 standard deviation, subtract the closing price today from 3 periods moving average value yesterday and calculate the square root of this difference. Repeat this process for 2 more days and add the square roots to find a value. Now take the inverse square root of this value to find the Standard Deviation.
Bollinger Bands calculation involve three simple formulas. First is the center line which is moving average of a stock, its measurement is very easy. If you want to calculate moving average of a Forex pair for 20 days, just add the closing value of that pair for 20 consecutive days and then divide it by 20.
The second Bollinger Bands calculation is of Upper Bollinger Band, which is obtained by multiplying the standard deviation by a factor (which is typically 2) and then the adding it to the moving average. The formula for calculating the upper band would be MOV20+(2*standard deviation).
Last Bollinger Bands calculation is of Lower Bollinger Band, which is calculated by multiplying the standard deviation by a factor and then subtracting it from the moving average. Putting this statement in the formula gives MOV20-(2*standard deviation).
How to Read Bollinger Bands Signals
Let’s now switch to how to read Bollinger Bands and what the bands are commonly used for:
- Trend Reversal Signals
- Measuring Volatility
Bollinger Band Trend Reversal Signals
When a candlestick closes outside a Bollinger band, it is called breaking the band. “Breaking the bands” occur in extremely volatile conditions and suggests that trend reversal is imminent. It is one of the strongest signals generated by Bollinger Bands.
Two standard deviations (Bollinger bands) include 95% of the data of a normal pattern. So any Forex Pair only has 5% probability of breaking the bands. When Candlestick breaks above band, it is called overbought condition and when it breaks lower band it is called oversold condition, both of these conditions are reversal signals as shown below:
Measuring Volatility with Bollinger Bands
Bollinger Band gives a very clear picture of volatility. Wide Bollinger bands signal increased volatility and Narrow Bollinger depicts reduced volatility in price as shown in chart below:
Bollinger Bands Trading Strategy
A simple trading strategy can be made by using Bollinger Bands with RSI and signals generated be the candlesticks. One can’t simply buy or sell on closing price breaking the Bollinger Bands. Let’s explain this with the help of an example; if price closes above upper band we will look at RSI, if it is above 70 then our two indicators will be indicating the overbought condition. But we will still wait for another indicator before initiating the trade which will be a candle opposite to the continuing trend. That is, if trend is upward, it breaks upward Bollinger RSI is equal to or more than 70 and there are few green candles in a row we will wait for a negative(red candle) which opens outside the Bollinger Band and closes below it before “selling” the pair like shown in chart below:
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