The Bollinger Bands Strategy Guide
In this article, we will teach you how to use Bollinger Bands to trade Forex, before providing several of our favourite Bollinger Bands strategies, complete with examples. So, if you are interested in learning more about Bollinger Bands, or looking for a Bollinger Bands strategy for the Forex markets, keep reading!
Table of Contents
Bollinger Bands Explained
Bollinger Bands are a popular technical indicator which use standard deviation to establish where a band of likely support and resistance levels might be found. This is a specific utilisation of a broader concept known as a volatility channel.
A volatility channel plots lines above and below a central measure of price. These lines, also known as envelopes or bands, widen or contract according to how volatile or non-volatile a market is. Bollinger Bands measure market volatility and provide lots of useful information, including:
- Trend continuation or reversal
- Periods of market consolidation
- Periods of upcoming large volatility breakouts
- Possible market tops or bottoms and potential price targets
Bollinger Bands consist of three lines, the middle of which is a Simple Moving Average (SMA) with the default value of 20. The upper and lower band are found two standard deviations either side of the SMA.
How do Bollinger Bands Work?
The most basic interpretation of Bollinger Bands is that the channels represent a measure of 'highness' and 'lowness'. Let's sum up three key points about Bollinger bands:
- The upper band shows a level that is statistically high or expensive
- The lower band shows a level that is statistically low or cheap
- The Bollinger Band width correlates to the volatility of the market
- In a more volatile market, Bollinger Bands widen
- In a less volatile market, the bands narrow
The Bollinger Bands contain a default setting in Forex trading as (20,2) - where 20 is the value for the SMA and 2 refers to the number of standard deviations the upper and lower band are either side of the SMA.
When using trading bands, it is the price action as it nears the edges of the band that should be of particular interest to us. For a technical analyst, trading near the outer bands provides an element of confidence that there is resistance (upper boundary) or support (bottom boundary), however, this alone does not provide relevant buy or sell signals; all that it determines is whether the prices are high or low, on a relative basis.
Bollinger Bands can be applied to virtually any market or security. For beginners, the default Bollinger Band settings are a good starting point.
As you lengthen the number of periods involved, you need to increase the number of standard deviations employed. At 50 periods, two and a half standard deviations are a good selection, whilst at 10 periods; one and a half perform the job quite well.
The Bollinger Bands Formula
The default Bollinger Bands® formula consists of:
- An N-period moving average (MA)
- An upper band at K times and an N-period standard deviation above the moving average (MA + Kσ)
- A lower band at K times and an N-period standard deviation below the moving average (MA − Kσ)
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Double Bollinger Band Strategy
Now we understand this technical indicator better, it is time to look at our first Bollinger Bands strategy.
The Double Bollinger Band Strategy is a Forex trading strategy popularised by Kathy Lien, a well-known Forex analyst and trader, who wrote in her book - 'The Little Book of Currency Trading' – that this was her favourite trading method.
The Double Bollinger Band Strategy is simple to learn and can be used for any actively traded asset on big liquid markets, such as Forex, stocks and commodities. As the name suggest, it requires adding two sets of Bollinger Bands to a single price chart.
Double Bollinger Bands Settings
This is how you apply the Double Bollinger Bands settings in MetaTrader 5:
- Click the ‘Insert’ menu at the top of the screen, select ‘Indicators’, ‘Trend’ and then ‘Bollinger Bands’
- Set the ‘Period’ as 20 and ‘Deviations’ as 2, leave ‘Shift’ as the default 0
- Insert a second set Bollinger Bands with a different colour
- For the second indicator, set the ‘Period’ as 20 and ‘Deviations’ as 1, leave ‘Shift’ as the default 0 again
Once the chart has been set up, it is time to mark the zones.
In the chart above, the Bollinger Bands in blue have settings of (20,2) and its outer bands are marked A1 and A2. The red Bollinger Bands have settings of (20,1) and its outer bands are marked as B1 and B2. Their shared SMA is labelled X.
The Double Bollinger Band Strategy contains three distinct trading zones:
- The Buy Zone is between lines A1 and B1
- The Neutral Zone is between lines B1 and B2
- The Sell Zone is between lines B2 and A2
The DBB Buy Zone
When the price is within the buy zone, it tells us that the uptrend is strong, and that there is a higher chance that the price will continue upward.
As long as the price candles continue to close in the buy zone, the odds favour maintaining current long positions or even opening new ones.
The DBB Sell Zone
When the price is in the sell zone, a downtrend will probably continue. That tells us that as long as the candles close in the lowest zone, a trader should maintain current short positions or open new ones.
The DBB Neutral Zone
When the price gets within the area defined by B1 and B2, the neutral zone, there is no strong trend, and the price is likely to fluctuate within a trading range because momentum is no longer strong enough for traders to continue the trend. The 20-day simple moving average (X) that serves as the baseline for both Bollinger Bands is in the centre of the zone.
According to the rules, whichever zone the price is in will signal whether you should be trading in the direction of the trend, long or short.
Basically, if the price is in the buy zone, you go long, if it's in the sell zone, you go short. If the price is in the two middle quarters (the neutral zone), you should restrain from trading if you are a pure trend trader, or trade shorter-term trends within the prevailing trading range. Usually, with the Double Bollinger Bands Strategy, traders trade higher time frames such as H4 or daily.
The Bollinger Bands Scalping Strategy
Next up is a Bollinger Bands scalping strategy, for those who prefer trading on the shortest timeframes. Five indicators are applied to the price chart:
- Bollinger Bands - (14,1) - green
- Admirals Pivot (H1) – Available only with Admirals MetaTrader Supreme Edition
- Bill Williams' Awesome Oscillator
- RSI (14)
- Exponential Moving Average (EMA) - (4) - black
The time frame for trading this Bollinger Bands scalping strategy can be either 1 minute, 5 minutes, or 15 minutes.
Targets are Admiral Pivot points, which are set on an H1 time frame. A stop loss is placed below the interim Admiral Pivot support (for long trades) or above the interim Admiral Pivot resistance (for short trades). This Bollinger Band scalping strategy should ideally be traded with major Forex currency pairs.
A buy trade is entered when the black 4-EMA crosses up above the middle Bollinger Band, at the same time, the Awesome Oscillator should be crossing its zero lines, going up, and the RSI should be coming up and crossing its 50 line.
In the chart below, there are two such opportunities highlighted by the red vertical lines.
For sell positions, you are essentially looking for the opposite conditions of buy trades. The 4 EMA needs to be crossing below the middle Bollinger band, at the same time as the Awesome Oscillator is crossing below the zero line and the RSI is crossing below the 50 line.
In the chart below, there are two sell indicators marked by the red vertical lines.
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The Bollinger Band Squeeze Strategy
This Bollinger Bands strategy, known as the Bollinger Band Squeeze Strategy, uses two indicators:
The recommended time-frames for this Bollinger bands trading strategy are M30-D1 charts and it can be applied to any instrument.
For the Bollinger Band Squeeze Strategy, the Admiral Keltner indicator should be added to your price chart with the following settings applied:
The chart below shows the Bollinger Bands added in green. In two separate places, the blue arrows are indicating areas where the outer lines of the Bollinger Bands have contracted and are seemingly squeezing the central SMA. Identifying these areas where there is a Bollinger Band squeeze is integral to this Bollinger Band strategy.
But how can we identify a valid Bollinger Band squeeze as far as this strategy is concerned? This is where the Admiral Keltner indicator comes in. Below is the same chart as above, however, this time we have added the Admiral Keltner in black.
For the purposes of this Bollinger Band trading strategy, you should only trade a setup when both the upper and lower Bollinger Bands squeeze inside the Keltner channel.
The Bollinger Bands and Keltner Channels notify you when a market is transitioning from a period of lower volatility to a period of higher volatility. Using these two indicators together will provide more strength, compared with using just a single indicator.
- Wait for the outer Bollinger Bands to contract and go inside the Keltner channel – the start of the Bollinger Band squeeze
- Once the upper and lower Bollinger Bands have both moved back outside the Keltner channel the squeeze has been released and a move is about to take place
- Wait for a buy or sell trigger
Above is the same chart, again, this time with the Bollinger Band squeezes highlighted in yellow and the release after the first squeeze marked by a vertical red line (note, the second squeeze had not ended at the time the chart was captured).
Once the squeeze has been released, the next stage of this Bollinger Bands strategy is to wait for a trade trigger, but what are these?
Buy: When a squeeze is formed, wait for the release, and then wait for the price to break above the upper Bollinger Band for a long entry.
Sell: When a squeeze is formed, wait for the release, and then wait for the price to break below the lower Bollinger Band for a short entry.
After both the Bollinger Band squeeze and release have taken place, we simply need to wait for the candle to break above or below the Bollinger Bands and then enter a position. Below are a couple of examples of this Bollinger Bands trading strategy in action with squeezes, releases and trade triggers highlighted.
It is important to note when using this Bollinger Bands strategy, that there is not always an entry signal after the release. This occurs when no breakout candle could trigger the trade.
For stop losses and targets, it is recommended to once again use the Admiral Pivot indicator. The stop-loss for buy trades is placed 5-10 pips below the middle Bollinger Band, or below the closest Admiral Pivot support, while the stop-loss for short trades is placed 5-10 pips above the middle Bollinger Band, or above the closest Admiral Pivot support.
Target levels are calculated with the Admiral Pivot indicator. For an M30-H1 chart, we use daily pivots, for H4 and daily charts, we use weekly pivots.
Bollinger Band Breakout Strategy
This is a long-term trend-following Bollinger Band trading strategy and the rules are simple:
- You take a long position if the previous close breaks above the upper band
- You take a short position if the previous close drops below the bottom channel.
The image below shows a daily chart of the USDJPY currency pair with Bollinger Bands 2.5 standard deviations away from a 200-day moving average. See how we get a buy signal, marked by the red vertical line, in March 2021?
You will also note that, in the same price chart, there were two false signals in February and March 2020. The profitability from this strategy comes from the winning payoff exceeding the number of losing trades. Psychologically speaking, this can be tough, and many traders find counter-trend Bollinger Bands strategies are less trying.
Counter-Trend Bollinger Band Trading Strategy
The chart below shows an hourly chart for the EURUSD currency pair with the following indicators:
- Bollinger Bands (20,2); and
- RSI (14).
The currency pair in the chart featured above is for the most part, in a range-bound state. See how the Bollinger Bands do a pretty good job of defining the support and resistance levels?
It's by no means precise, but the upper and lower bands do tend to reflect where the direction reverses. Recognising that this is not an exact science is another key aspect of understanding Bollinger Bands and their use for counter-trend Forex trading.
When the market approaches one of the bands, there is a good chance we will see the direction reverse sometime soon thereafter. However, a counter-trend trader has to be very careful, and exercising proper risk management is a good way of achieving this. Remember, in any range-bound market, eventually, prices will break out. Here's the key point - you need to shut down a losing position quickly if there is any sign of a proper breakout.
In the chart above, an RSI has been added as a filter to try and improve the effectiveness of the signals generated by this Bollinger Bands strategy. This will reduce the number of overall trades, but should hopefully increase the ratio of winners.
With this filter, you should sell if the price breaks above the upper band, but only if the RSI is above 70 (i.e. indicating an overbought market). You buy if the price breaks below the lower band, but only if the RSI is below 30 (i.e. indicating an oversold market).
The CCI or Stochastic Oscillator indicators could also be used to create a similar Bollinger Bands trading strategy to the above. Generally speaking, it is a good idea to use a secondary indicator like this, not just with Bollinger Bands, to confirm what the primary indicator is saying and to, therefore, help ensure trading signals are more reliable.
We hope you enjoyed our Bollinger Bands strategy guide and now have a better understanding of how to use Bollinger Bands to trade Forex as well as learning a few Bollinger Bands strategies.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.