Both the Bollinger bands and stochastic oscillator are popular indicators for trading forex. They can help us to identify currency pair trends and momentum, whilst also spotting range bound markets and reversal trade opportunities. When you combine both of them, you can filter out some of the false signals that may occur when using either of them on their own. I also like to include price action analysis to time my entry, including candlestick patterns along with support and resistance. In this guide I will look at a simple Bollinger bands and stochastic strategy that you can use to analyse currency pair charts on different timeframes to find trading signals.
What are Bollinger Bands?
Bollinger bands were developed by John Bollinger and are used to measure a market’s volatility and identify overbought or oversold conditions. Bollinger bands consist of a middle band (which is a moving average) and an upper and lower band. If the bands are narrow, the market might be ranging whereas widening bands suggests a strong trend.
Bollinger bands can help you to identify sharp, short-term price movements and potential entry and exit points. They can be used to read the trend strength, to time entries during range markets and to find potential market tops. Flexible and visually intuitive to forex traders, Bollinger bands can be a helpful technical analysis tool for trading both band breakouts and band reversals.
What is the stochastic oscillator?
The stochastic oscillator is a great technical indicator for spotting overbought and oversold market conditions along with trend direction. When the stochastic is above 80, the market is considered overbought. If the stochastic is below 20, the market may be oversold. When the stochastic crossover of the main and signal line happens upwards, this shows an uptrend. When the stochastic main line crosses the signal line downwards, this shows a downtrend.
How to trade the Bollinger bands and stochastic strategy?
We will combine all of the different elements of the Bollinger bands and stochastic together so we only take trades when they all agree. This can give our strategy that extra edge and help to filter some false signals. We will also look at how price is reacting to key price levels to time our entry.
We will be looking to enter in the direction of a new trend to try and catch some big moves. Both indicators will be used to spot extreme buy or sell conditions, then the stochastic crossover will be used to time our entry into the direction of the trend.
You can use this Bollinger bands and stochastic strategy on any chart timeframe or currency pair. I personally prefer the 1-hour charts and above as they tend to have less noise when compared to the lower chart timeframes. It also means less time spent watching the charts but therefore less trading signals. You can also use multiple timeframe analysis to confirm trades over the short and long-term.
I like to trade major currency pairs such as the EUR/USD and GBP/USD as they usually have lots of liquidity which means we can catch some good market moves and place trades with tight spreads and quick execution speeds. This is especially the case when using an ECN forex brokers such as IC Markets.
Buy signal
- Price is below the lower Bollinger band (20, 2)
- Stochastic crossover (5, 3, 3) in the extreme sell zone (0-20)
- Bullish price action
In the EUR/USD 1-hour chart below, you can see that price breached the lower Bollinger band whilst the stochastic crossed over upwards in the extremely oversold zone. A level of support was formed and price started to head upwards, confirmed with a three white soldiers candlestick pattern. If we placed the stop loss just below the support level, it would have only been around 10 pips. When you consider this was a significant uptrend that went on for over 500 pips, the risk to reward ratio was very favourable. That is good as it means one bad trade would not wipe out lots of winners. I would try to shoot for at least 1:3 risk to reward ratio is possible. The stochastic had more crossovers on the way up, which could have been later entries into this uptrend.
Sell signal
- Price is above the upper Bollinger band (20, 2)
- Stochastic crossover (5, 3, 3) in the extreme buy zone (80-100)
- Bearish price action
You can see from the EUR/USD 1-hour chart below that price had breached the upper Bollinger band and then hit a resistance level. It started to turn downwards as confirmed by the stochastic crossing downwards above the extreme buy level. This suggests that buyers had lost momentum and we were going to see a down trend commence. The entry was confirmed with bearish price action including a hanging man candlestick pattern. We could have placed the stop loss just above the recent high point (resistance) which would have only been 15 pips. Not bad when you consider the market fell for around 450 pips in just 1 week. You will see there were ample opportunities to enter this downtrend with numerous stochastic crossovers on the way down. The upper Bollinger band could have been used as a trailing stop which would have seen us catch most of this particular move.
Bollinger bands and stochastic strategy Pros & Cons
Pros
- Catch big forex trends early
- Easy to interpret signals
- Can be combined with other analysis
- Can be used on any currency pair and timeframe
- Bollinger bands and stochastic indicators are free to use
Cons
- Requires confirmation via further analysis
- Takes time to learn how to time entry and exit
- Will still be false trading signals
- Need sensible money management
Conclusion: is the Bollinger bands and stochastic forex strategy any good?
Yes, as you can see from the examples I have shared, trading forex with the Bollinger bands and stochastics together can produce some good buy and sell trades. However, I would not trade them blindly without first confirming each trade with my own market analysis. It is also important to consider any fundamental analysis that can impact price, including major economic news releases.
Not to mention, you will need good forex money management so that you don’t wipe out all of your gains in one bad trade. I would look to lock winning trades in at break even point and utilise a trailing stop to try and maximise each market trend. You should also have great trading discipline and keep your emotions in check. These are all factors that can have a big impact on the results of any forex trading strategy.
If you like the look of the Bollinger bands and stochastic strategy, you could always give it a try on a demo account to see how it goes. You can get a free forex demo account from most forex brokers. I would always practice any manual or automated forex strategy on demo at first in order to understand how it works and see if it produces the desired results before taking any risks.
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.
