Measuring Forex Market’s Volatility Using Bollinger Bands
Technical analysis has become very common in the forex market. Bollinger Bands, created by John Bollinger in the 1980s, is being used for exceptional insights into price and volatility. He used a moving average technique with two trading bands. The bands have to be above and below the MA.
Compared to a normal MA, the percentage calculation of Bollinger bands is attained by adding and subtracting a standard deviation calculation. Standard deviation measures volatility to show how the market stock price varies from its actual value.
Hence, Bollinger bands adjust to the market condition by measuring the price volatility. Using Bollinger bands, a forex trader can find the price data they need between the two bands.
How Bollinger Bands Work
Bollinger bands are made of two bands above and below the EMA (exponential moving average) centerline on a trading chart. The two bands are price channels showing the standard deviation of the stock you are studying.
Whenever the price action of the issue expands or contracts, the bands expand. The issue will expand when the issue becomes volatile and contract when it is bound into a tight trading pattern. Despite volatility from time to time, the stock can trade for a prolonged period in a forex trend.
Using moving averages, traders can better see the trend and filter the price action. This allows the trader to gather more information about how the forex market is trading.
If a sharp rise or fall occurs in a trend, the market tends to consolidate, appearing to crisscross above or below the moving average. You can monitor the trend’s behavior using price channels that encompass the trading activity around a trend.
The forex market is sustained by traders who trade on a daily basis, whether they are trading in an uptrend or downtrend. Using moving averages, technicians anticipate the price action of the stock using support and resistance lines.
You can expect the pride to be contained if the upper resistance and lower support lines are drawn and extrapolated to create promising channels. You can be confident that the price will keep moving as expected if the prices don’t move out of the channel.
Bollinger bands can help you note when a price is becoming overbought. On the chart, the stock price will touch the upper Bollinger band. If the stock price touches the lower band, the prices will be oversold, giving you a cue to buy.
We recommend designating the upper and lower bands as your price targets when using Bollinger bands. The middle line represents the 20-day average; if the price deflects off the lower Bollinger bands to cross above the upper line, then the upper band represents the upper price target.
If it’s an uptrend, the price will fluctuate between the 20-day moving average and the upper band. Expect a trend reversal to the downside if the price fluctuation crosses below the 20-day MA.
The downside of Bollinger Bands
While this indicator can be pretty helpful for a forex trader, it can also be limiting because it cannot be used as just one indicator. For better insight, Bollinger bands should be used with 2 -3 indicators that are in-correlated.
The indicator has settings that will allow you to apply Bollinger bands guidelines to a specific asset in day trading. You can look at the historical charts in the settings to see how the indicator would have helped you in previous trades.
However, if you think the indicator wasn’t of any help in the historical chart, then you can opt not to use the bands to trade the asset in the settings. Bollinger band settings tend to vary from one market to another, and they can be altered over time or used to trade the same instrument.
The indicator has also been linked to producing false signals. For instance, one may spot a wrong reversal signal because the bands might contract during low volatility times, particularly if the price moves sideways. Such times the price could just be bouncing off both bands and not necessarily to indicate a reversal signal.
When using Bollinger bands in forex trading, remember that it is more of a tool than a perfect indicator. It is up to you to apply Bollinger band settings to work for the asset you are dating and understand that the indicator will not always produce reliable information.