The primary idea of Bollinger Bands is to sell when price reaches the upper Bollinger band and buy when it falls down to the bottom Bollinger band. In forex market where price movements are going up and down this technique works well for determining your next trading strategy.
What do these Bollinger bands look like? There are two lines separated by a distance from one another. The distance changes along with the price movements. When there is not much changes in price movement the bands are close from one another, but when the price goes up, the distance between two lines increases. Bollinger bands add and subtract a standard deviation calculation that measures the instability of price movements enclosing at least 80% of the price inside the "tunnel" the bands create.
Another line which is a part of Bollinger Bands is the simple moving average right in the middle of the tunnel.
There is a lot of mathematics behind this, but we will not go too much into details. All you have to know is that
- An upper band is the simple moving average plus 2 standard deviations.
- A lower band is the simple moving average minus 2 standard deviations.
This definition should be enough! Your forex broker trading platform should have this tool available for you and so here we will discuss the application of Bollinger bounce rather then the actual calculations.
The price can bounce from one band to another, each time creating trading possibility. Think of Bollinger bands as two pin-pong players and the middle line (simple moving average) as their ball. When the simple moving average (our pin pong ball) is getting closer to one of the band (one of the excited players) it bounces off – just like the pin pong ball would do when one of the players hits it back!
Ok, great! Now we know where the word bounce in "Bollinger bounce" comes from. Now what? It is useful to understand that when you see the simple moving average approaching one of the bands it will almost certainly bounce back off!
Another imaginary example – let's say that the simple moving average (the middle line) is a gas and the Bollinger bands form a sealed gallon. When you squeeze the gallon with a dangerous gas at some point the gallon explodes and the gas gets out. So, that's exactly what happens with Bollinger squeeze – when Bollinger bands squeeze close to each other there is a great chance that there will be an "explosion"! If the middle line (the simple moving average) breaks through one of the bands, either the top or the bottom) it is believed that forex trend will continue in that fashion.