One of the most popular forex strategies for currency pairs that are trading in a range is the Bollinger bands reversal strategy. I find Bollinger bands to be the ideal technical indicator for picking tops and bottoms in a range bound market. The key thing is to first determine when a currency pair is not trending and trading within a range. Once you have determined this, Bollinger band reversals can be highly effective, especially when combined with other forms of market analysis.
What are Bollinger bands?
Bollinger bands help determine whether prices are high or low on a relative basis. They are used in pairs, both upper and lower bands and in conjunction with a moving average. There are a number of uses for Bollinger bands, such as determining overbought and oversold levels, as a trend following indicator, and for discovering breakouts of support and resistance levels.
I personally feel that Bollinger bands are one of the most reliable and powerful forex trading indicators that traders can choose from. They have multiple purposes so can adapt to all types of market conditions. They can be used to read the strength of a currency pair trend, to time entries and exits during range bound markets and to find potential market tops or bottoms.
How to trade Bollinger band reversals
As mentioned above, there are many ways in which you can trade with Bollinger bands, including Bollinger band breakouts and Bollinger bands reversals. When trading reversals, we are looking for price to breach either the upper band for a short (sell) trade or the lower band for a buy (long) trade.
We wouldn’t want to blindly take every reversal signal as the market could be trending which might see use get stopped out over and over again. However, you may find that you take a reversal trade that actually ends up as the start of a new trend which would be the ideal entry point in that instance.
To identify ranging markets, we can use a volatility indicator such as the average true range (ATR) which measures volatility, taking into account any gaps in the price movement. Typically, the ATR calculation is based on 14 periods, which can be intraday, daily, weekly, or monthly. If the ATR is below a certain level then it suggests the currency pair is ranging and we might want to consider trading Bollinger band reversals.
If you want even more confirmation that the market is not trending, you could also use the volumes indicator. Low trading volumes tend to suggest fewer participants and lower levels of interest in the currency pair in question. Low volumes may, therefore, reveal weakness in the market and present opportunity to pick of the high and lows with Bollinger band reversals.
Buy signal
- Price is below lower Bollinger band (20, 2)
- Volumes indicator showing low activity
- ATR is showing low volatility
- Bullish price action patterns
You can see from the USD/JPY 15-minute chart below that the volumes indicator and ATR are showing that we may be in a quiet market period. It is the evening in the USA so it is normal to see less trading activity on the USD which can provide good conditions for reversal trading. The price went below the Bollinger band a few times, giving multiple buy signals. There are hammer candlestick patterns on each to confirm bullish sentiment. We could have taken profit at the middle or upper Bollinger bands for 3 successful trades.
Sell signal
- Price is above upper Bollinger band (20, 2)
- Volumes indicator showing low activity
- ATR is showing low volatility
- Bearish price action patterns
The USD/JPY 15-minute chart below is the same as that for the buy signals but instead I have marked off the sell signals. You can see the condition have all been met, this time the price is above the upper Bollinger band so we are trading reversals to the sell side. If we were taking profit at the middle or lower bands, we would have had 3 good trades again. We could even have traded both long and short, to capitalise on this ranging market. This would have given 6 good trades over a period of around 8-12 hours.
Bollinger bands reversal strategy Pros & Cons
Pros
- Can be used on any currency pair
- Can be used on any chart timeframe
- Can be combined with many other indicators
- Give entry and exit points in range bound markets
- Relatively easy to interpret the buy and sell signals
- Bollinger bands is a free technical indicator
Cons
- Requires additional confirmation
- Needs good money management
- False signals during trending markets
- Moves can be smaller than trend trading or breakouts
Conclusion: does the Bollinger bands reversal strategy work?
Yes, I think Bollinger band reversals are one of the best strategies for range bound markets. Another good technical indicator for trading reversals are moving average envelopes. I like that Bollinger bands are dynamic so adapt to the current market conditions and do not lag as much as some other indicators.
However, any forex strategy is only as good as the trader who is using it. If you don’t have good forex money management in place, chances are you will not see good results. I would look to cut bad trades short and let winning trades run as much as possible. This is especially important when trading in ranges as the moves tend to not be as significant as when you are riding trends.
If you are looking to trade reversals along with breakouts, then you can always give the Bollinger bands reversal strategy a try on a forex demo account. You can practice your forex strategies on a demo account until you build up enough confidence and start seeing consistent results.
You can get a free demo account from most forex brokers including IC Markets. They are my top choice for manual trading and forex expert advisors. This is because I find them to have tight spreads, low commission fees and excellent customer support.
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.
