Bollinger Bands: Using Volatility As a Technical Indicator

Day traders use Bollinger Bands® as a technical indicator to display a chart reading of volatility by how tight they are around a financial instrument. The degree of tightening or widening them surrounding the price action of a financial instrument determines the level of volatility. Chart facing, a 21-day moving average (preferred period of time) is surrounded by an upper and lower Bollinger Band®. They are meant to serve as a technical indicator of overbought (wide bands) and oversold (tight bands) market conditions.

How Are Bollinger Bands® Read?

Looking at financial instrument charting software with 'tight' Bollinger Bands® applied to the price action, a significant move to the up or down side may occur soon. However, if a financial instrument chart has 'wide' bands applied to price action, this may signal a significant move is not likely to occur in the not too distant future. Tight and wide, they can also be used as a counter technical indicator of both potential low and high volatility in that present price action is used to predict a different, future market move.

With the above said, the best conditions for the indicator's use are periods of low volatility with scant price fluctuation. The more time passed in a low volatility environment, the more they will tighten around a financial instrument's price action. When tightening more than usual, the bands may be signaling an increase in future volatility.

How Can Bollinger Bands® Be Used?

When analyzing Bollinger Bands® with the intention of day trading online, do not rush to make a decision if price action breaches the top or bottom band, as this is not always an indication of an immediate market move. That said, though most price action movement occurs within the indicator, a breach of an outer band is a rare occurrence indeed, but cannot be relied on to be a guaranteed buy/sell signal. In addition, though widely used, Bollinger Bands® are actually meant to be used in tandem with two or more other technical indicators such as Relative Strength Index (RSI) and MACD.

It is important to note, before day trading based on a signal derived from Bollinger Bands® and two other indicators, backtesting historical market trends with all of these indicators is strongly suggested. Backtesting these indicators against the historical market trend you are focusing on will provide an idea of how your strategy would have performed in historical market conditions.

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An Introduction to Price Action Trading

What is Price Action?

This is the art of making your trading decisions based off of reading the price movement on the chart. This is done without any indicators, the only thing that really should be on the chart should be your Support and Resistance areas.

Now remember by 'Action' in Price Action, we are referring to the movement of price on any given chart. Remember, every single chart tells the story of a battle between the Bulls (the Buyers) and the Bears (the Sellers). This is what every single chart shows (Forex or otherwise). What influences the movement of price is traders making trading decisions (manual or automatic).

Price Action shows you the most up to date market sentiment, because it's happening right there in front of your eyes! Using indicators are often lagging, which is why sometimes you will enter a trade based off an indicator hoping that it will go well, only to have price turn against you! (Never go in to a trade 'hoping' it will go well, we are looking for high probability - low risk trades, in other words it makes sense to execute!).

Price Action = Trading the CAUSE

Once I understood this, it was a real penny drop moment. I had been trading the EFFECT of price movement, which is why I had been inconsistent. Trading this way meant that I could trade the cause of price movement and get in on the potential move very early on.

How to trade Price Action

There are four main elements to trading Price Action:

(1) Fundamental Analysis

(2) Technical Analysis

(3) Support and Resistance

(4) Candlestick Analysis

On the surface this may seem incredibly overwhelming, but once you have a clear understanding of these elements, you will see that they are very simple to do.

Let us now look at each of these four elements in more detail:

(1) Fundamental Analysis

This is extremely important, always keep an eye on the global economic news, remember we are trading Forex, Foreign Exchange. We are trading currency pairs, there are going to be certain global economic news events that will have an effect on the movement of price.

(2) Technical Analysis

Technical Analysis in Price Action Trading, is recognizing certain patterns on the chart that may give an indication for a potential trade. Remember, the charts are subjective, the reason they move in the way that they do is because of traders making trading decisions.

Traders will look at a chart and see that in the past price moved sharply down from a certain area, price is now reaching the same area and so they look for the same thing to happen. As Human Beings we are always looking for patterns and similarities.

So, Technical Analysis is immensely important in understanding and identifying potential trades. We look for those potential trades at areas of Support and Resistance.

(3) Support and Resistance

Support and Resistance are those areas on the chart where we believe there are heavy influxes of Buyers (at Support) and Sellers (at Resistance). These are our areas of trade opportunities, as they offer the highest probability - lowest risk trades.

This leads us to the final piece of the puzzle, Candlestick Analysis.

(4) Candlestick Analysis

Candlestick Analysis, as the name suggests is analyzing the candlesticks. We do this candle by candle in order to ensure we are aware of the latest, the most up to date and therefore the most accurate market sentiment. This is why trading the higher time frames, is key because it shows us Price Action that spans a larger amount of time. If you had two candles, a 5 min candle and a 12 hour candle, the one that would be of more importance would be the 12 hour candle, because it represents a longer period of Price Action.

So, there you have it a brief introduction to Price Action. Study it, master it and become consistently profitable.

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