A Closer Look at Bollinger Bands
Welcome to one of our foreign exchange advanced topics, an introduction to forex Bollinger bands. We have John Bollinger to thank for inventing the forex Bollinger Bands technical analysis tool in the 1980s. Bollinger Bands is an addition to the trading bands concept, and can be utilized to measure how high or low the current price is relative to past trades.
FX Bollinger Bands comprise of:
- a lower band calculated at K multiplied by an N Period standard deviation (this will be below the centre band)
- a centre band calculated at a simple moving average N Period
- an upper band calculated at K multiplied by an N Period standard deviation (this will be above the centre band)
A typical value for N is 20 and the typical value for K is 2. A simple moving average is usually the default choice for the average, although other types of averages are also employed as needed. Normally the same time period is used to calculate both the standard deviation and the centre band.
Bollinger Bands have 2 indicators, namely %b and BandWidth.
%b, is pronounced as 'percent b', and is derived from the Stochastics formula that indicates where you are relative to the bands. %b equals 0 at the lower band and 1 at the upper band.
%b equals (last-lowerBB) divided by (upperBB-lowerBB)
The BandWidth explains the width of the Bollinger Bands, when they are measured on a normalized basis.BandWidth equals= (upperBB-lowerBB) divided /by centreBB
BandWidth is equal to 4 times the 20-period coefficient of variation, when utilizing the default parameters of a twenty-period look back, plus/minus 2 standard deviations. %b can be used for pattern recognition and system building. BandWidth can be used to identify opportunities that arise from relative extremes in trend identification and volatility.
The purpose of Bollinger trading bands is to give a relative definition of low and high. By definition, prices are low at the lower band and high at the upper band. This definition is useful when we compare the price action to the indicators action to make systematic trading decisions.
Some investors buy when price reaches the lower Bollinger Band and sell when price reaches the moving average in the middle of the bands trading. Other investors buy when forex price breaks above the top foreign currency Bollinger Band or on the other hand sell when price falls below the lower foreign currency Bollinger Band. Furthermore, not only stock traders use Bollinger trading Bands, it is actually widely used in the trade markets.