By Teresa Burnett
The technical indicator known as Bollinger Bands can be an effective tool in any currency trading strategy. Bollinger Bands are a standard deviation plotted around a moving average. Illustration 1 shows Bollinger Bands with the default settings of two standard deviations plotted above and below a 20 period simple moving average.
Illustration 1
Numerous systems abound for interpreting the width of the Bollinger Bands (the distance between the upper and lower bands) to predict price movement. I would like to share a unique interpretation of the bands that works particularly well with trading currencies and that interpretation is to evaluate not the width of the bands but rather the slope.
When the slope of the bands is minimal, in other words, when the upper and lower bands flatten it predicts a reversal as price touches and retreats from the flat band. The relative steepness or flatness of a band can be seen visually and does not require a complicated formula to assess.
Illustration 2
Illustration 2 shows a weekly chart of the EUR/USD pair
from May through December, 2006. Note that in October the lower Bollinger Band has flattened. Price repeatedly touched this flat lower band over a two week period near the price of 1.2500 and then climbed steadily to the current early December, 2006 highs of 1.3300.
The upper Bollinger Band flattened on the USD/CHF weekly chart during September and October, 2006 which predicted a powerful movement away from the upper band near the price of 1.2700 down to the lower band near the price of 1.2150 as seen in Illustration 3. At this writing, price has declined further to 1.1910.
Illustration 3
There is something for every currency trader using this technique from the scalper seeking to capture numerous 5 pip moves in a day to the position trader playing for several hundred pip moves over the course of several weeks. In the next section we will examine strategies for timing currency trade entries using Bollinger Bands in various time frames.
I will stop here. Watch out for part 2 of this article
