3 Bollinger Bands Strategies that You Need to Know

The experienced Forex traders might have many trading tools in their arsenal. One of the most popular ones is the Bollinger Bands. This method was introduced and developed by John Bollinger in the 1980s.
 
Actually it takes three lines to compose Bollinger Bands. In the middle, we have the first one which is the Simple Moving Average of a specific number of periods; here most often traders use 20-day SMA. This line has upper and lower bands, both of which move with the price changes. The distance between those two lines is dependent on the standard deviation. So essentially, in times of high market volatility the bands are wider, than under normal conditions. The opposite is also true.
 
There are essentially three Bollinger Bands strategies traders can use in their technical analysis.
 
The first method among the Bollinger bands indicator strategies focuses on identifying the strength and the momentum of the latest trends, especially the currency pairs which trade near upper or lower bands.
 
The second, called Breakout Strategy focuses on identifying potential reversals or trend continuations when the price gets outside two bands.
 
Finally, the third method called Squeeze can be helpful in forecasting market volatility and consequently the timing of opening and closing trades.
 
All those strategies can be helpful in identifying and timing the potential tops and bottoms for Forex currency pairs, therefore it is still one of the most popular trading tools for traders.
 

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Bollinger Bands Trading Strategy Guide

In this article, we will address 3 Bollinger band strategies:
 
  • Trend Trading
  • Breakout Strategy
  • Squeeze Strategy
 
Before moving on to those techniques, we will analyze the Bollinger Bands formula itself.
 

Bollinger Bands Equation Explained

This might sound complicated, but the Bollinger bands’ calculation strategies are very simple. The first essential element for constructing any Bollinger Bands chart is the closing prices of the currency pair in question. Most traders make use of the last 20 periods, whether that will be hourly, daily or weekly charts. For example, the use of 20-day moving averages in Bollinger Bands analysis is very common. In this case, the trader would need to calculate the average number from the closing prices of the last 20 trading days of the currency pair.
 
The next step involves the calculation of the standard deviation. This indicator measures the average variance. To determine the boundaries of the upper band, the standard deviation is added to the moving average and for the lower band, the standard deviation is subtracted from the 20-day SMA.
 
Eventually, the Bollinger Bands chart might look like this:

 

Bollinger Bands Forex strategy
The image above shows the long term technical picture of EUR/USD. The purple line represents the market close rates, the blue one - the simple moving average of the last 20 periods. Finally, red and green lines denote the upper and lower bands respectively.
 
As we can see from the chart above, during the last 3 years and 3 months, most market price action takes place within the Bollinger Bands.
 
At the beginning of 2017, the EUR/USD still traded near parity levels, very close to the lower band. After initial decline the pair recovered notably, slicing through the 20-month simple moving average and reached the upper band.
 
In fact, this was the first time in this chart when the price broke out for a brief period of time. After some correction the strength of the Euro once more pushed the exchange rate higher, getting above the upper band for a second time. Regardless of that, just like in the first case this was very much short-lived.
 
However, it was different from the previous occasion in the sense that this time marked a major reversal. After two false breakouts, the tide has finally turned. The EUR/USD declined steadily and nowadays the pair trades near the lower band.
 
Interestingly enough, some traders even use the double Bollinger Bands when forming their Forex strategy. Those types of charts are especially similar to the original, with the difference that it employs two sets of standard deviations. So instead of one, there are two upper and lower bands above and below the simple moving average line.
 
This measurement, in some ways, addresses the concern, that many traders have a hard time interpreting the breaks above and below the outer lines. So having two additional sets of bands in the chart can, in some cases, be helpful with technical analysis.
 

Bollinger Bands Trend Trading Forex Strategy

Trying to identify and follow strong trends is the simplest of Bollinger Bands’ trading methods. The famous professional Forex trader and mentor Vladimir Ribakov makes several observations on this issue.

Firstly he states in his analysis that during strong trends, the price stays close to outer bands. From our chart above we can see two lengthy periods of this. During the second half of 2017, the EUR/USD price action stayed very close to the upper band. The trend itself was quite solid with Euro appreciating from $1.06 all the way up to near $1.25 in less than a year.
Bollinger Bands explained
Another example of this development started in late 2018  and one could argue that this goes on even today;, since nowadays the price of EUR/USD is close to the lower bound. The pair has been in long term downtrend since it pulled away from the 2017 highs and eventually went down below 1.10 mark.
 
The second observation, which Ribakov makes is that a break of the moving average is often the sign that the trend is ending. We can see two examples of this from the chart above. After the collapse of the EUR/USD during 2014-2015 the pair stayed near-parity levels for some time. However, as the price broke through during spring 2017, the bearish trend for Euro ended and currency appreciated significantly.
 
As the price of EUR/USD pulled away from the upper band and eventually moved below the simple moving average, the pair resumed its long term downtrend and nowadays still trades near-parity levels.
 
So how to use Bollinger Bands in Forex trading based on that information above? Well, the trader can analyze charts of several currency pairs. Then he or she can select those securities, where the price movements are following lower or upper bands closely, since as mentioned before this can suggest the existence of a strong trend. Therefore the trader can open long positions with currency pairs with signals of an uptrend and short positions with the signals of a downtrend.

Bollinger Bands Breakouts Forex Strategy

Any Bollinger Bands Forex guide will be incomplete without addressing this question: how can we deal with breakouts? Around 90% of price actions are confined within upper and lower bands, but what happens to the trend if the market closes above or below those boundaries?
 
Answers to this question might form one of the Bollinger Bands strategies that work. In fact, the author of this trading system himself might have some advice for this. John Bollinger mentions in his 8th rule that if the market closes outside the bands initially are the signs of trend continuation, not a reversal.
 
As Vladimir Ribakov mentions in some of his works, if the spikes into the upper or lower band are immediately rejected, then this might be a sign of trend reversal. We can see several real-life examples of this when taking a look at the recent developments in some Major Forex pairs. For example, in terms of daily Bollinger Bands charts the advances below the lower bands of EUR/USD and USD/JPY have been eventually rejected, and instead of continuing their downtrend the exchange rates of both of those currencies recovered.
 
However, there are several scenarios where the currency pair can overcome the upper band. We can see from our chart, that EUR/USD has closed well above the red line and this trend of appreciation continued for approximately 6 months. The trend changed its direction decisively only after the market price moved below the simple moving average level.
 
Therefore, this can be used as one of the Bollinger Bands indicator strategies. The trader can take the advice of John Bollinger and look for the currency pairs which have decisively overcome upper or lower bands and open trading positions, which can profit from the continuation of this trend. If later the exchange rates change direction, it might be advisable to close the position.

Bollinger Bands Squeeze Strategy

The third Bollinger Bands Forex strategy aims to measure the latest trends of market volatility and subsequently forecast the possible changes in this type of indicator. Returning to the chart above, we can see that the actual distance between the upper and lower bands is not fixed. In the case of EUR/USD, they were much wider in late 2017 to early 2018, compared to the present situation.
 
The reason behind this phenomenon is that as mentioned before, the distance between the outer Bollinger bands is dependent upon the standard deviation, consequently, when markets become less volatile the bands start to narrow, this is called a Squeeze.
 
We can see the example of this in the chart, whereas a result of a lower degree of variation between EUR/USD exchange rates, the distance between the upper and lower bands became much closer. So, the pair is in the ‘Squeeze’ stage of the cycle.
 
The appearance of this scenario does not provide any signals for the beginning of any bullish or bearish trend. It simply can indicate that sooner or later the higher volatility is going to return in the market.
 
The opposite is also true. If the distance between the outer bands remains large for a considerable amount of time, then it might be a sign that eventually they will start narrowing again and the trader can prepare for lower market volatility.
 
Consequently, the Bollinger Bands Squeeze strategy seeks to identify those Forex pairs which have their upper and lower bands narrowed significantly. This might forecast a greater degree of variation in the exchange rates for the future and by extension, more trading opportunities.
 
Essentially, strategies for this Bollinger Bands indicator at mt4 and all other trading platforms focus on finding Forex pairs with potentially higher volatility and open positions in favor of the prevailing trend.
 

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Bollinger Bands Explained - Key Takeaways

  • Breakout of the currency pair above the upper Bollinger Band is not always a bullish sign for the pair. In fact, as an expert in trading, Vladimir Ribakov mentioned, if this type of move is rejected by the market, it can point to reversal.
 Bollinger Bands indicator strategies
  • The usage of Bollinger Bands is not strictly limited to 20 days moving average analysis, it can be used for such a short timeframe as 5 minutes or as long as on monthly charts.
  • Using Bollinger Bands strategies does not always guarantee success, major economic events and other factors can disturb the usual market patterns. Therefore, the best Forex strategy might be to combine technical and fundamental analysis.

FAQ: Bollinger Bands Trading Strategy

What was the last time the Forex Major currency pair has broken out of Bollinger Bands?

This depends on the timeframe of the Bollinger Bands chart. If we take the common 20-day simple moving average, in case of EUR/USD, the pair closed below the lower bound on March 19th, 2020, with the common currency falling below $1.07. However, after three days of high volatility, this move was eventually rejected and EUR/USD recovered, trading near the 1.08-1.10 range.
 
When it comes to USD/JPY, it crossed over the lower bound on February 28th, 2020. The downtrend here was stronger, running for 7 consecutive trading days and pushing the pair from 108 down to near 102 mark. During the middle of March, the trend reversed and returned to previous levels.
 
GBP/USD had an even more dramatic decline. From the March 10th, the Pound began its downtrend, slicing through the lower band just in a matter of 2 days, eventually collapsing from 1.31 to 1.15. This pair also recovered, but unlike other examples, it still trades well below the February levels.


Did the Author of Bollinger Bands publish any tips for trading Bollinger Bands?

Actually John Bollinger organized his tips into ‘22 Bollinger Band rules’. This includes several valuable advice for traders, for example in the 10th rule the author tells us that the middle Bollinger Band is not the best one for crossovers, but rather it should be used as an intermediate-term trend indicator.
 
At the end of his list, the author warns us that the bands do not provide continued advice, but they can help us identify the setups where the odds might be in our favor. The full list of those tips was published in the 1980s and is widely used by traders.


Can the Bollinger Bands help traders and investors with identifying undervalued and overvalued currencies?

Some traders classify the currency pairs which trade near the upper band as ‘overbought’ and the ones near lower band as ‘oversold’. So they might base some of their trading decisions on those indicators.
 
However, at the same time, It might be useful to keep in mind that the Bollinger Bands is a part of technical rather than fundamental analysis. The variables of this type of analysis are taken from the latest price action and it does not take into account such economic factors as interest rate differentials or relative Purchasing Power Parity levels. Therefore, the Bollinger Bands might not be the best tool for identifying undervalued and overvalued currencies.


How do Exponential Bands differ from their traditional counterpart?

The author of Bollinger Bands addresses this issue in his 12th and 13th rules. According to him, the Exponential bands are different in the sense that they eliminate the sudden changes in the width of the bands due to large price variations leaving the back of the calculation window.
 
John Bollinger also notes that in this type of chart, the exponential averages must be used for all of the three lines, both for middle, upper and lower bands.
 

What are some of the other popular technical indicators?

The Bollinger Bands strategies are not the only Forex trading techniques used by traders. In fact, several Bollinger band indicator guides recommend combining it with other technical indicators.
 
For example, the Relative Strength Indicator (RSI) is another popular trading tool for market participants. This was invented by J.Welles Widen, it measures the strength of the market and is expressed by numbers from 0 to 100. If the indicator is close to the upper or lower extremes, then this might indicate the overbought or oversold market conditions respectively.
 
The Moving Average Convergence Divergence (MACD) is another popular trading tool. In the case of the daily chart,  It is calculated by subtracting the 26-day Exponential Moving Average (EMA) from the 12-day EMA. MACD is also used by traders to identify the oversold or overbought conditions in the market.

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