The Bollinger Bands indicator, named after its creator John Bollinger, is a popular member of the “Trend” family of technical indicators. Bollinger designed his bands in order to measure if prices were high or low on a comparative basis with relative volatility. Traders use the bands to anticipate increases and decreases in volatility that signal imminent trend changes are on the way.
The Bollinger Bands indicator reflects upon trend information by combining a moving average with the underlying currency’s volatility. The indicator looks like an expanding and contracting envelope drawn about the pricing indicia on a typical chart. The two boundary lines represent two standard deviations of distance above and below the moving average. Over time, the bands act like an accordion playing music
Bollinger Bands Formula
The Bollinger Bands indicator is common on Metatrader4 trading software, and the calculation formula sequence involves these straightforward steps:
- Calculate a Simple Moving Average of price behavior (Standard period setting is “20”, but can be customized to suit your taste);
- Calculate “Upper Limit” line by adding “2” standard deviations to the SMA (Standard setting is “2”, but can me modified);
- Calculate “Lower limit” line in similar fashion to “Upper Limit”.
Software programs perform the necessary computational work and produce asset of Bollinger Bands as displayed in the following chart:
The Bollinger Bands indicator consists of the three fluctuating lines designated in “blue” in the above chart. In the example above, the Upper Limit and Lower Limit Bollinger Bands encompass the candlestick formations and the “blue” SMA or midpoint line. When the bands contract, price consolidation is occurring and volatility is low. These periods are typically followed by a breakout signified by expanding bands and volatility.
Over time, prices tend to move to the centerline after “hugging” one of the limit lines. The Upper Limit denotes resistance, and the Lower Limit represents support, valuable information that traders often use to construct their execution plans. The benefit of the Bollinger Bands indicator is its visual simplicity, the reason that it is one of the most popular indicators and that it appears frequently on forex commentary illustrations.
The next article in this series on the Bollinger Bands indicator will discuss how this oscillator is used in forex trading and how to read the various graphical signals that are generated.
Next Article >> A trading strategy based on the Bollinger Bands Indicator >>