This is the third article in our Bollinger Bands series. If you haven’t already, we suggest that you check out the first article about the Bollinger Bands Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the Bollinger Bands indicator. John 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.
Traders focus on the key points of reference for the Bollinger Bands, which are band bounces and squeeze reactions. The “Bollinger Bands Accordion” reflects how volatility varies with price behavior. When the candlesticks “hug” one boundary limit, they tend to “bounce” back to the centerline. When the bands “squeeze”, they also tend to expand quickly thereafter as a price breakout follows a consolidation.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points, both conservative and aggressive, that can be discerned from using Bollinger Bands analysis. Using the Bollinger Bands in combination with another technical indicator is also always recommended.
A simple trading system would then be:
- Determine your entry point after a “squeeze” of consolidation occurs and when the candlesticks begin to pierce the upper limit;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point when two topping candlesticks form above the upper limit signaling a strong move back to the centerline.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded a profitable trades of 40 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, Bollinger Band Technical Analysis will provide you with an “edge”.
That concludes our series on the Bollinger Bands Indicator. For further reading visit our Forex indicators section.
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