Bollinger bands are great for helping to identify market ranges and breakouts. Many traders use the Bollinger bands reversal strategy to try and pick the tops and bottoms of a range bound market, or the Bollinger Bands breakout strategy to enter when price breaches support or resistance. I like to keep my options open and trade both strategies depending on the current market conditions. I will not only look for how price reacts around the upper and middle bands, but also give great consideration to Bollinger bands divergence. This is something that I feel is often overlooked, especially by new traders who have only been taught the very basics of using the versatile and powerful Bollinger bands indicator.
What are Bollinger bands?
Bollinger bands are one of the most popular technical analysis tools, where three different lines are drawn, with one below and one above the currency price. Its specific period moving average (20 by default) is denoted as midline to form envelopes around the market prices.
These lines show a band or a volatility range in which a particular currency price is moving up or down. Volatility is shown on the basis of standard deviation (2.0 by default) for a particular currency cross, which is denoted by upper and lower line/band, as standard deviation is a measure of volatility.
How to use Bollinger bands?
You can use the Bollinger bands to trade breakouts above the upper or lower bands. You can also use them to trade reversals when price breaches either of the bands in a range bound market. If you look for Bollinger band divergence, this can help to filter out some false signals and confirm entry points. I think it is a good idea to combine all elements of the Bollinger bands along with other technical indicators and price action analysis to gain that extra edge.
What is the Bollinger bands divergence strategy?
Divergence refers to the disconnect between price action and price momentum. When price increases as momentum weakens, negative divergence occurs, and when price decreases as momentum weakens, positive divergence occurs.
If you see the Bollinger bands divergence is to the upside, it might be a sign that the market is going to continue heading upwards. Likewise, if the Bollinger bands divergence is to the, we might be expecting the market to keep falling.
Buy signal
- Bollinger bands divergence to the upside
- Price is making higher lows
- Stochastic crossover near extreme 20 level
- Bullish price action
In the USD/CHF 1-hour chart below, we can see that all of the conditions have been met. This would have allowed us to get in on a good upwards trend. There is strong Bollinger bands divergence to the upside, whilst the stochastic oscillator has crossed over in an upwards direction around the extreme oversold 20 level. The price does eventually break through the strong resistance level and once it does, there is plenty of momentum to the upside. The stop loss could have been placed just below the lower Bollinger band which would have been around 25 pips. When you consider this uptrend continued for over 700 pips, this trade had a very favourable risk to reward ratio.
Sell signal
- Bollinger bands divergence to the downside
- Price is making lower highs
- Stochastic crossover near extreme 80 level
- Bearish price action
In the USD/CHF 1-hour chart below, you can see that there is strong Bollinger bands divergence to the downside. The market is falling and making new lower highs which confirms strong downwards momentum. The stochastic crossover has occurred and we can see some bearish candlestick patterns whilst price has bounced a few times from a recent resistance level. We could have placed the stop loss just above the recent swing high which would have been around 10 pips only. Considering this trade went downwards for over 250 pips, there was plenty of opportunity to take profits along the way.
Bollinger bands divergence strategy Pros & Cons
Pros
- Catch big currency pair trends
- Works well with other technical indicators
- Can be used on any instrument and chart timeframe
- Easy to spot Bollinger bands divergence once you know how
Cons
- Takes some time to master entry and exit
- Requires confirmation from additional market analysis
- Need to have good money management
Conclusion: should I try the Bollinger bands divergence strategy?
If you are a fan of the Bollinger bands indicator, then I think you should certainly be looking for Bollinger band divergence when considering any buy or sell signals. This strategy can be implemented along with your existing strategies or used as is.
Regardless, you will need to have good forex money management to ensure that you do not wipe out a few winning trades with just one loss. I would try to cut losing trades short and let winners run. I might even lock in good trades at breakeven point and use a trailing stop to maximise each move as much as possible. You will also need good trading discipline, try not to let negative emotions such as fear, anger and greed get in your way.
As with any forex strategy, I would test it out on a demo account to begin with and see how you get on. You can get a free demo account from most forex brokers which can be a great way o practice your trading strategies and improve your skills with virtual funds.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
