Developed by technical trader J. Bollinger in 80s. Bollinger bands are using moving average (MA) together with two trading bands (above and below). Those are calculated by adding and subtracting standard deviation.
Standard deviation as used in BB is tool of measuring market volatility. Bollinger bands therefore adjust themselves to conditions on forex chart and subsequently visualise, how much can price vary from its average value.
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Anatomy of Bollinger bands
BB are created by centre line and two channels surrounding it. Centre line is calculated as EMA or MA (Exponential moving average or simple moving average). Two channel lines drawn on the sides, are calculated as standard deviation and therefore can expand or shrink according to market volatility. Narrow BB tunnel clearly shows low volatility and it is widened as market volatility rises.
Use of Bollinger bands
By connecting Bollinger bands indicator with manually drawn trendline, forex trader can establish width of a trend tunnel with high certainty.
When price repeatedly touches and closes above upper Bollinger Bands line, market can be considered to be overbought.
When price repeatedly touches and closes under lower Bollinger Bands line, market can be considered to be oversold.
Channel lines of BB can be used as profit targets and stop loss levels.
Bollinger bands are often used as confirmation of price action. For example, pin bar reverse formation (forex strategy) found on BB channel boundaries is considered to be confirmed reverse signal.
Bollinger bands can be coupled with oscillators such as RSI (Relative strength index) to find suitable entry, within forex trend and specific market volatility.
Reverse Bollinger bands approach. Various studies have confirmed that Bollinger bands can be employed as contrarian indicator at some market conditions.