Topic: Forex Market: Bollinger Band Technical Indicator
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Traders trading in the foreign exchange market are well aware of a powerful technical analysis tool called Bollinger Band. It is a technical indicator that can be used in any financial market. Bollinger Bands help a trader to identify the overbought and oversold levels in the Forex market.
What is Bollinger Band?
Bollinger Band was developed by John Bollinger in 1980. He was an experienced technical analyst in the market. The technique uses moving averages that operate within two parallel lines. These are known as bands. Bollinger Bands calculation consists of addition and subtraction of standard deviation. Mathematical formula of standard deviation helps in measuring the market volatility. The prices are tested to show their variation from the true value. Bollinger Bands set themselves according to market conditions. Traders can easily notice all the prices between the bands.
Exponential moving average forms the centreline between two price bands in the Bollinger Bands. The bands or channels are derived by finding out the standard deviations of the assets. The expansion and the contraction of the bands depend on the price action. If the prices are volatile, the bands will expand. The bands will contract, if the prices jump into a trading pattern which is tight. If there is some volatility, traders can trade for longer period during a trend.
Price action is generally filtered using moving averages. Market trading information is revealed to the traders. Forex market is dynamic and can change many times on a daily basis. This can happen even when there is a prevailing trend in the market. Expected price action is derived using moving average with support and resistance. Extrapolation of the upper resistance and lower support helps the traders to form channels. The prices remain within the channels. Generally, there are a few traders who draw straight lines by connecting tops or bottoms of the prices to spot the upper and lower extreme of the prices. Parallel lines are drawn. They are the fixed channels inside which the prices should move.
In overbought price situation, the stock prices will touch the upper Bollinger Band. When the prices continuously touch the lower Bollinger Band, it is called oversold situation, in which the traders should buy. The upper and lower band serves as the price target in the Bollinger tool. When the price diverges away from lower band and crosses above the centreline, the upper band is considered the upper target of the price. The price will move within the centreline and upper band when there is a strong uptrend. Traders must note the warning of trend reversal, if the prices move below the moving average line.
Bollinger squeeze reflects the market volatility. Volatility is easy to spot using Bollinger Band as assets have alternative phases of low and high volatility. Bollinger squeeze equation is given below:
Width of Bollinger Band= (top Bollinger Band- bottom Bollinger Band)/ simple moving average
Bollinger Bands are considered low, if they are closer to each other. They are considered highly volatile, if the bands are apart. When volatility reaches the six-month low, squeeze is triggered.
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