Bollinger bands are named after the person who developed them, John Bollinger. It is a moving average technique that is used to measure the volatility of a market with the help of two trading bands that are placed above and below the current market trend providing a boundary of highs and lows. A middle line running between the two bands is the trend indicator that indicates the price movements and volatility because of which the Bollinger bands (upper and lower ones) adjust to the current market situation. These fundamentals of Bollinger Bands let you decide if the market is quiet or loud.
When the bands are close to each other, it means that the market is quiet. But when the bands widen, it shows that there is more volatility in the market and hence they are loud.
One thing that you as a forex trader should be aware of regarding the fundamentals of Bollinger bands is that every quiet with low volatility for some period actually signals the building up of a storm that would be loud enough to be witnessed by all the traders in the market.
Bollinger Bands Calculation
The center line which is your exponential moving average and the two price channels, upper and lower bands are determined on the chart with the help of a simple calculation which is as follows:
- Upper Band = Middle Band + 2 * 20-day standard deviations in price
- Lower Band = Middle Band – 2 * 20-day standard deviations in price
- Middle Band = 20-day moving average
These two most common strategies are designed and implemented by forex traders to catch on early the trading opportunities these changes bring with them.
The Bollinger Bounce
A basic concept upon which the fundamentals of Bollinger bands function is that the price tends to return to the middle of the band after at every uptrend or downtrend. This is the reason why this is called a Bollinger Bounce. A Bollinger Bounce occurs because the two price channels or bands function as support and resistance levels for the market. The longer the market behaves in a similar manner, the stronger and more accurate these bands would get. A Bollinger Band strategy works well when the market is ranging and no clear trend can be predicted.
The Bollinger Squeeze
Bollinger Squeeze can be explained in the same manner as the Bollinger Bounce, in that as the bands squeeze together, it indicates a period of quietness and signals that a breakout is about to happen which will lead the bands to spread out thus creating volatility. If the price movement along with the market starts moving upwards, then it means an uptrend has started which will basically continue for a while. Same goes for a downtrend. So if the tightness breaks out by markets moving downwards, then it is likely that this pattern with wider bands is going to continue for some time.
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