How to Use Bollinger Bands

Bollinger Bands may very well be one of the most useful technical indicators. Compared to other trading indicators, you can think of Bollinger Bands as a Swiss army knife—there’s so many uses for them that Bollinger Bands are almost ubiquitous with technical analysis.

This technical indicator is based on market volatility. When the market is moving fast in one direction (the market is trending) Bollinger Bands widen. When the market slows, Bollinger Bands contract. The following chart shows how Bollinger Bands work:

As you can see, the market was flat, and the Bollinger Bands came closer together, but when the market moved quickly and violently, the Bollinger Bands expanded.

The basic concept is simple: the outer bounds of a Bollinger Band tend to work as support and resistance, and in an ideal market, the price of a currency pair will always be right in the middle. Of course, markets don’t always work this way—a market can be overbought or oversold, which is how forex traders make money by buying or selling at the right price.

Support and Resistance

In a clear trending market, traders can use the Bollinger Bands to define support and resistance. A trader might buy and sell based on touches to the band, as shown here:

Forex traders profit by buying and selling within a trading range based on Bollinger band support and resistance points.

The bands also provide for one more variable: volatility. Markets are fairly calm, but during periods of volatility, the markets can move quickly in both directions, and even in one direction. One of the best ways to trade Bollinger Bands is to play the cyclicality of volatility.

Volatility usually comes in a series. With the Bollinger Bands, we know that the trade has to eventually break out and move. When the Bollinger Bands are very tight, the next move up or down is sure to be large. With forex and in meteorology, it’s always calm before the storm.

Check out this chart, which shows how a trader can latch onto a developing surge in volatility: