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Bollinger Bands ® are among the most reliable and potent trading indicators traders can choose from. They can be used to read market and trend strength, to time entries during range markets and to find potential market tops. The indicator is also not a lagging indicator because it always adjusts to price action in real time.
In this article, we show you how to use Bollinger Bands ® to improve your chart reading skills and to identify high probability trade entries.
In our pro Forex trading course, you will learn how to use the Bollinger Bands ® to find and time entries step by step.
Bollinger Bands ® explained 101
As the name implies, Bollinger Bands ® are price channels (bands) that are plotted above and below price.
The outer Bollinger Bands ® are based on price volatility, which means that they expand when price fluctuates and trends strongly, and the Bands contract during sideways consolidations and low momentum trends.
By default, the Bollinger Bands ® are set to 2.0 Standard deviations. However, we suggest setting them to 2.5 Standard Deviations to make them wider and capture more price action. With the 2.5 standard deviations, 99% of all price action falls between the two bands, which means that a violation of the outer bands becomes a much more meaningful signal as we will see.
The center of the Bollinger Bands ® is the 20-period moving average and the perfect addition to the volatility based outer bands.
Trend-trading with the Bollinger Bands ®
Bollinger Bands ® do not lag because they always change automatically with price.
In my own trading, I use this indicator for one of my setups. If you want to learn how to find the best trades every week, take a look at our premium trading course.
We can use the Bollinger Bands ® to analyze the strength of trends and get a lot of important information this way. There are just a few things you need to pay attention to when it comes to using Bollinger Bands ® to analyze trend strength:
- During strong trends, price stays close to the outer band
- If price pulls away from the outer band as the trend continues, it shows fading momentum
- Repeated pushes into the outer bands that don’t actually reach the band show a lack of power
The screenshot below shows how much information a trader can pull from using Bollinger Bands ® alone. Let me walk you through the points 1 to 5:
1) Price is in a strong downtrend and price stays close to the outer bands all the time. This is a very bearish signal.
2) Price fails to reach the outer band and then shots up very strongly.
3) 3 swing highs with lower highs. The first swing high reached the outer band whereas the following two failed .
4) A strong downtrend where price stayed close to the outer band. It tried to pull away, but bears were always in control.
5) Price consolidates sideways, not reaching the outer band anymore and the rejection-pinbar ended the downtrend.
As you can see, the Bollinger Bands ® alone can provide a lot of information about trend strength and the balance between bulls and bears.
We highly recommend combining the Bollinger Bands ® with the RSI indicator – it’s the perfect match. There are two types of tops that you need to know about:
2) During a consolidation, price spikes into the outer Bands which get rejected immediately
The screenshot below shows both scenarios. The first is the top after a divergence. You can see how the trend became weaker and then eventually failed to reach the outer Band before reversing. I marked the second spike with an arrow which was a trend continuation signal as price failed to break higher during the downtrend. The strong spike that was followed by a fast rejection showed that bulls lacked power.
You can see that the Bollinger Bands ® are a multi-faceted trading indicator that can provide you with lots information about trend, buy/seller balances and about potential trend shifts. Together with the moving average and the RSI, Bollinger Bands ® make for a great foundation for a trading strategy.
If you want to learn how to trade profitably with a step by step trading approach and a powerful trading system, take a look at our premium trading courses.
See the Bollinger Bands ® in action