One of the most often used types of technical indicators is Bollinger Bands, which was developed by John Bollinger. It is a valuable indicator that gives moving averages a fresh perspective. Here, I’ll introduce you to the Bollinger Bandwidth indicator and go over some of the most basic ways to use it when trading. First things first, let’s talk about the indicator before we go into the strategies.
What is the Bollinger Bandwidth Indicator?
To properly grasp the Bollinger Bandwidth indicator, we must first understand what Bollinger Bands are. The Bollinger Bands are a volatility indicator that plots three lines in relation to the price of a security. Usually, a 20-day simple moving average is used for the middle line. The upper and lower bands are 2 standard deviations above and below the SMA (middle line).
The indicator is typically used in trend-following and channel strategies. Below is a chart of the EUR/USD featuring Bollinger Bands.
The Bollinger Bandwidth indicator calculates the difference in percentage between the upper and lower bands. When Bollinger bands widen, the bandwidth usually goes up, and when Bollinger bands narrow, the bandwidth usually goes down. Therefore, it is a vital indicator for measuring market volatility. The Bollinger Bandwidth is functionally quite different from Bollinger Bands; thus, the two should not be confused. The indicator is a rising and falling oscillator, as seen below.
Bollinger Bandwidth Strategy
Although the Bollinger Bandwidth can be used in the market, its application is sometimes quite limited. Traders use it in a variety of ways. As one of the best-known concepts about Bollinger Bands, the theory that volatility frequently varies between periods of expansion (bands widening) and contraction (bands narrowing) is widely accepted. When the bandwidth is low, market volatility is minimal. This is commonly referred to as a “squeeze.” When this happens, it means that a breakout in either direction is likely to happen soon.
The squeeze setup is easily identified by two activities:
- There is a low-volatility phase. Since the bands are so close together, the price is probably just going to fluctuate slowly.
- After the period of low volatility, volatility spikes, and the price either breaks through the Upper Band or falls through the Lower Band, signaling an end to the ranging phase and the start of a new directional trend.
Buy Signal
- Switch to higher timeframes to help reduce market noise.
- Examine the charts to see if it is moving in an upward trend.
- Identify key support levels on the Bollinger bandwidth indicator to avoid dealing with false market movements.
- Analyze the risk-to-reward ratio using your preferred SL and TP levels before entering the long trade.
- After carefully analyzing the relevant parameters, you might place your buy order.
Sell Signal
- Switch to higher timeframes to help reduce market noise.
- Examine the charts to see if it is moving in a downtrend.
- Identify major resistance levels on the Bollinger bandwidth indicator to avoid dealing with false market movements.
- Analyze the risk-to-reward ratio using your preferred SL and TP levels before entering the short trade.
- After carefully analyzing the relevant parameters, you might place your sell order.
The Bollinger Bandwidth indicator doesn’t help traders in any other way, so they have to use combine it with other methods to confirm entry and exit points. This may be determined by price action, the original Bollinger Band, candlestick patterns, support and resistance, along with other concepts.
Bollinger Bandwidth Indicator Pros & Cons
Pros
- The Bollinger Bandwidth is a useful tool for analyzing market volatility and spotting probable trend reversals.
- The Bollinger Bandwidth Indicator can be used in tandem with other technical analysis tools, such as Bollinger Bands and moving averages, to confirm trade signals.
- It identifies price swings with strong potential (high risk-reward ratios if using sensible forex money management)
Cons
- False signals are common when using the Bollinger Bandwidth indicator independently, without the support of any other technical indicators or fundamental analysis.
- The Bollinger Bandwidth indicator doesn’t offer further trade support, so traders have to use other tools to confirm when to buy and sell.
- It is used in varying conditions, making it difficult for new traders to tell them apart
Conclusion
Bollinger Band Width is a tool used in technical analysis that can help find “The Squeeze,” which, when acted on, can give decent buy and sell signals provided you time your entry and exit well. Just keep in mind that the Bollinger Bandwidth indicator is subjective and may provide false signals; therefore, it shouldn’t be implemented alone without confirmation from other technical indicators or fundamental analysis. Even so, an analyst or trader who is well prepared can catch some good currency pair moves when a strong uptrend or downtrend comes after a squeeze.
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.
