There are many ways in which you can include Bollinger bands in your forex strategy, whether that be using them to trade breakouts, reversals or simply as a confirmation tool. The Bollinger bands breakout strategy can be used to spot buy and sell signals on any currency pair and chart timeframe. The popularity of the indicator means that many traders are watching it, which can make it one of the more reliable technical indicators when utilised correctly.
What are Bollinger bands?
In order to fully understand the Bollinger band breakout strategy, it is important to have a clear understanding of how the indicator works. Bollinger Bands are envelopes that are plotted at a standard deviation level above and below a simple moving average of the price. Bollinger bands help determine whether prices are high or low on a relative basis.
Because the distance of the bands is based on standard deviation, they adjust to volatility swings in the underlying price. Bollinger Bands use 2 parameters, Period and Standard Deviations.
Bollinger Bands typically use a 20-period moving average, where the “period” could be 5 minutes, an hour or a day. It depends on the chart timeframe that you are using. You can get more Bollinger band signals on the lower chart timeframes but there is more noise which can mean more false signals.
Volatility is measured using standard deviation, which changes with increases or decreases in volatility. By default, the upper and lower bands are set two standard deviations above and below the moving average. When the bands are wider, it suggests the market is volatile and trending. If the bands are narrow, it suggests the market is trading within a range.
What is the Bollinger bands breakout strategy?
This is a simple forex trading strategy where you look to take a long (buy) position if price breaks out above the upper band, or a short (sell) position if price breaks below the lower band. The Bollinger band middle line can be used to place the stop loss and exit a position when the market turns around.
You can trade the Bollinger band breakout strategy on its own, which is very easy to do. However, I find that it works best when combined with other market analysis. I wouldn’t blindly take each breakout of the Bollinger bands without first confirming with at least one more technical indicator such as the RSI or MACD. I would also check price action around the breakout to make sure we have breached recent support or resistance levels.
- Price breaks above the upper band
- RSI is around the oversold area and showing bullish divergence
- MACD histogram is showing an uptrend
- Price has breached recent resistance levels
- Trade is confirmed with other analysis (optional)
- Stop loss can be placed on middle or lower band (optional)
- Exit on cross of lower band (optional)
On the EUR/USD 1-hour chart below, you can see that price breached the upper band whilst the MACD main line crossed the zero line and was above the signal line. There was bullish RSI divergence whilst price broke the recent resistance level and price action was showing a morning star candlestick pattern. These are all strong buy signals and as it turned out, the trade moved around 180 pips in our favour before crossing the opposite side of the band for an exit point. We could have used the middle or lower band as the initial stop loss level and moved it up along with the trade to lock in the trade.
- Price breaks below the lower band
- RSI is around the overbought area and showing bearish divergence
- MACD histogram is showing a downtrend
- Price has breached recent support levels
- Trade is confirmed with other analysis (optional)
- Stop loss can be placed on middle or upper band (optional)
- Exit on cross of upper band (optional)
You can see in the EUR/USD 1-hour chart below that price breached the lower Bollinger band. The RSI (14) was showing divergence for a downtrend whilst the MACD (12,26,9) main line was below the signal line. There is also a hanging man candlestick pattern followed by an engulfing bar which confirms the entry point. The middle band would have worked as a stop loss area in this instance which would have been around 40 pips. If we used the upper band as an exit point, this trade would have made over 200 pips which gives a very favourable risk to reward ratio of around 1:5.
Bollinger bands breakout strategy Pros & Cons
- Can be used on any currency pair and chart timeframe
- Bollinger band indicator is free to use
- Can catch some big trends
- Provides optional entry, exit and stop loss levels
- Can be combined with many other indicators
- Works best when combined with other market analysis
- Can be false breakouts, especially on lower chart timeframes
- Requires trending market conditions
- Some traders use the bands for reversal strategies
Conclusion: is the Bollinger bands strategy any good?
Yes, I think that this is a solid trading strategy but it does require some input from the user. You will need to confirm the Bollinger band breakouts with your own market analysis and have sensible money management in place. This means that 2 forex traders using the Bollinger band breakout strategy could have completely different set of results.
I would look to take trades that present a favourable risk to reward ratio so that a loss does not wipe out a run of winners. I may also look to lock in good trades at breakeven point and trail the stop loss to try and maximise the potential of each move.
I think the Bollinger band signals are more reliable on the higher chart timeframes such as the 1-hour, 4-hour and daily charts. This is because there can be a lot more noise on short term charts which can lead to a higher chance of false signals. Longer term charts also mean less chart watching which is a bonus if you are short on time.
If you like the sound of this Bollinger bands strategy and want to give it a try, you could always try it on a forex demo account without any risk. You can get a free demo account from most forex brokers, including IC Markets who have tight spreads and quick execution speeds on a large range of currency pairs.
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