How to Use Bollinger Bands in Forex and Stock Trading

December 14th, 2012 by | Category: Technical Analysis

Bollinger Bands® is the second important indicator I use along with candlesticks. In fact, the combination of candlesticks and Bollinger Bands creates the strong trade setups I look for.

There are some awesome features in the Bollinger Bands that can not be found in any other indicator. Before talking about the the way we can use Bollinger Bands, lets see what kind of indicator it is, and how it looks like. If you don’t have Bollinger Bands on your chart, please add them and let the settings to be the default settings which is 20, 0, 2.

Bollinger Bands are consist of three lines: Bollinger Upper Band, Bollinger Lower Band and Bollinger Middle Band.

Bollinger Middle Band is nothing but a simple moving average. Bollinger Upper and Lower Bands measure deviations. I can bring their formula here, but it will not have any usage for your trading. The only thing we should know is that they are so strong in locating the trends and reversals. Combining the candlesticks patterns with Bollinger Bands, creates a great trading system that shows the strongest continuation and reversal trade setups.

Note: In all the below examples, the Bollinger Band setting is the default setting which is 20 period and 2 deviations.

How Can We Use Bollinger Bands in Trading and How Its Trade Setups Look Like?

1. Trend Trading:

One of the most important features of Bollinger Bands is that when the market is slow and there is no reasonable volatility, the upper and lower bands become close to each other:

As you see on the above image, Bollinger upper and lower bands have become so close to each other in the area that I have placed those white arrows. Keep in your mind that when the market becomes slow like that, and it makes a narrow range, a breakout that can be the beginning of a big trend is on the way. You can easily predict the direction of the breakout with the signals that the market already has shown. Just follow the numbers at the above image and you will see what I mean.

The candlestick #1 has a long lower shadow. What does that mean? It means a big Bullish pressure is imposed to the market suddenly. So the price wants to go up. This is the first signal. You could take a long position after this candle, but if you did not, the market would show you some more signals to go long.

After candle #1, market becomes slow and Bollinger upper and lower bands become so close to each other. Candle #2 shows a breakout with the Bollinger lower band, but it is closed above it. This candle also has a long lower shadow that reflects the upward pressure. Then the market becomes slow for several candles, BUT candle #3 assures you that the range is broken. So if you didn’t have a long position, you could go long at the close of #3 candle. Then some red candles are appeared, but you should know that after a range breakout, the very first reversal signal is not indeed a reversal signal. It is a continuation signal.

The above breakout could be the beginning of a big trend, but it is not. I just brought it here as an example of ranging market and its breakout. If the candlesticks movements make you confused, you can shift to the line chart from time to time and find the real support and resistance of the range. Line chart is plotted based on the close signal. Close signal is the most important thing specially when you want to interpret the signals with Bollinger Bands and predict the market. Let’s shift to line chart and see how it looks like:

As you see the support and resistance of the range are shown much better in the line chart (blue circles). Numbers 1, 2 and 3 are where the candles #1, #2 and #3 formed on the last image. In the above line chart the range breakout is confirmed while candle #3 was forming. The price line goes up, touches and rides the Bollinger Upper Band. This means the price has broken above the range, and now we have an uptrend.

So we learned that the close price is very important when we work with Bollinger Bands. A Bollinger Lower Band is not broken, as long as the candlesticks are being closed above it, and a Bollinger Upper Band is not broken yet, as long as the candlesticks are being closed below it.

Like the Fibonacci system I explained earlier, one of the ways to trade using the Bollinger Bands is finding a range and then waiting for its breakout.

Bollinger Bands are really good in trend following. Please follow the numbers in the below image. #1 shows a good reversal signal (I will talk about the Bollinger Bands reversal signals later in this article). If I wanted to take a long position I would wait for more confirmation which is the #2 candle. I would go long at the close of #2 candle.

The next a few candles break above the Bollinger Middle Band and the candles after them make a small ranging, BUT as you see all of them are closed above the Bollinger Middle Band (zone #3). Some of them tried to break down the Bollinger Middle Band, but they couldn’t. What does that mean?

It is another confirmation for the beginning of an uptrend. Zone #3 is the most important part of the below image. Conservative traders prefer to take their long positions after formation of such a confirmation. They go long when the thin red line is broken above (#4). They place the stop loss below the low of the last candle that its shadow is broken down the Bollinger Middle Band. As you see it goes up strongly (first red big arrow). There are some small red candles but they should not be considered as reversal signals. At #5 the price goes down to retest the Bollinger Middle Band. This is the beginning of the second Elliott Wave. It is where some traders wait for the retrace (continuation) to go long. I have explained it in another article I wrote about Fibonacci.

Can you take a short position at #5 ?

You can, but you’d better not to do that. It is against the trend direction and when you see the price has been going up strongly, and for such a long time, you should ignore the first and even the second reversal signal. They are not reversal. They are continuation signals in fact.

So the price goes down, retests the Bollinger Middle Band, and it even succeeds to break down the middle band, but keeps on going up again. As I have explained above, although it could break down the middle band we should not go short.

It starts going up again (#6) and the next candles are all closed above the Bollinger Middle Band. Fibonacci can be a big help here. As you see at #7 and when it wants to break above the 100.0% level, it shows a bearish reaction, but the next candle is closed above the Bollinger Middle Band and the next candle breaks above the 100.0% level (#8). We should expect it  to break above the 161.80% level, because it is a strong trend and as you see it can even reach the 261.80% level (#9) and break above it (#11).

Both when the uptrend is started seriously (#4) and when the 100.0% level is broken (#8), candles touch and ride the Bollinger Upper Band. It is the same as when we have a downtrend. Candles touch and ride the Bollinger Lower Band.

2. Reversal Trading:

Bollinger Bands are great in showing the reversal signals too. Usually a nice reversal signal becomes formed when a candlestick breaks out of one of the Bollinger Upper or Lower Bands, and then it is followed by another candle which has a different color. One of the best examples can be seen in the above image at #1. I am going to make the signal bigger and show it once again here:

As you see the candlestick #1 which is a bearish candlestick is formed completely out of the Bollinger Lower Band, and the next candlestick (#2) which is a bullish candlestick has covered the body and upper shadow and also most of the lower shadow of candlestick #1. These two candlesticks form a signal which is called Piercing Line. A Piercing Line which breaks out of the Bollinger Band is much much stronger. A Piercing Line is called Dark Cloud Cover when it forms at the top of a bull market. I strongly recommend you to learn the candlestick signals.

Here is some more reversal signals:

A long upper shadow that has broken out of the Bollinger Upper Band strongly

Bullish Engulf
Note how both candlesticks broken out of the Bollinger Lower Band and how the second candlestick has covered the first one totally.


Dark Cloud Cover
Note how both candlesticks broken out of the Bollinger Upper Band and how the second candlestick has covered the first one.
Also look at the big upper shadow that the second candlestick has.

False Signals:

We can always see some false signals. True signals are easier to catch, because they are strong and obvious. A good trader is someone who can distinguish and avoid the false signals: Strong Trade Setups Gauge

There are false range breakouts and also false reversal signals. Those who like to trade reversals will be encountered with more false signals because a trend can be continued for a long time, and it is not easy to say when a reversal occurs. If you like to avoid being trapped by false reversal signals just ignore the very first two reversal signals when there is a strong trend. Of course if you really wait for a big and strong breakout and you don’t rush to take a position when you see a weak and partial breakout, you will have less number of false reversal. For example some traders take a short position when they see the below signal, but as you see this is not a strong signal in comparison to the signals I showed you above:

Why Is the Above Signal False?

1. The uptrend is a strong, and this signal is the very first reversal signal. What do I mean by strong uptrend? Look at the uptrend slope. It is a sharp slope that is going up strongly. There is no sign of exhaustion in it yet. A trend has to show the exhaustion signals to tell us that reversal is close.

2. Although about 50% of both #1 and #2 candlesticks are placed out of the Bollinger Upper Band, this can not be considered as a strong signal because

  • Both candles are not long enough and are relatively short candles.

  • They don’t have any big upper shadow that reflects the power of a downward pressure.

  • The second candle is very short and it has not engulfed the first candle strongly.

Can you mention any more reason?

Here is two other examples for such a false reversal signal:

Can You Say Why Those Signals Are False?

The third signal can be known as a relatively true signal, because the uptrend is still strong. Look at the Bollinger Middle Band Slope (the first red arrow). So the trend is still strong and has not formed any sign of exhaustion when this relatively true signal was formed. You could take a short position, but you really had to get out when the continuation signals formed around the Bollinger Middle Band.

Now look at the below image and follow the numbers. Find out why some signals are false, some are true and some are continuation.

As you see Bollinger Middle Band works very well with continuation signals too. In an uptrend, continuation signals are formed when the candles go down, retest the Bollinger Middle Band, and then start going up again. In a downtrend, continuation signals are formed when the candles go up, retest the Bollinger Middle Band and then start going down again. Taking the continuation signals are much safer than reversal signals, unless you make sure that the trend is really close to reverse.



33 Comments:
  1. Sylvain:
    November 17, 2013 at 10:54 am

    Very Nice and well documented training.

    Thanks à lot

  2. Zaman:
    December 1, 2013 at 2:56 pm

    I have studied this most effective indicator explanation and got photo copy for ready reference. Indicator has been explained in very clear manner.I will use this strategy in my trade. Thanks a much for such demonstration.

  3. osama:
    December 28, 2013 at 3:19 pm

    great site great writer thank you very (bulish ) much

    • Kanaiya:
      March 13, 2014 at 1:20 am

      Great man…I have never seen such a great explanation even upon paying tuition fees. U r really Excellent. I am looking forward article from you regarding candlestick reversal signals and false signals…

  4. James:
    March 12, 2014 at 10:52 am

    I am really thankful to you for your valuable advice’s. I am learning from your article and that would be really helpful for all of us basically for me. So, thanks again and please try to help us to get more skilled with the other ways to do better in Forex trading.

  5. AGBAJE:
    March 20, 2014 at 12:46 pm

    i thank you very much for well detailed materials on candlesticks.

  6. Jaopsie:
    April 7, 2014 at 11:23 pm

    hi, im about to begin my trading and very quick temper person easy to irritate if my trading not so good, when my friend recommend me to read it, its quite difficult to understand but its to interesting a perfect tool to use in my trading.

  7. Lanze:
    June 26, 2014 at 4:53 am

    hm.. this article was very helpful.. thanks for the writer for help us understand the BB. From the start i was stick with the BB indicator but not use it with details. This could help me better in BB. thank you very much.. :)

  8. Joshua:
    July 2, 2014 at 6:31 am

    The break away gap in the last graph at 7# which was tagged relatively true reversal signal is also a confirmation of change in polarity. This occurred just after the bearish engulfing pattern at #7. My question is does break away gap join in fundamental analysis of a trend in such suitation?

  9. Raul:
    July 5, 2014 at 11:43 pm

    Thank you so much. The fact that you explain everything so clearly is amazing. The fact that you also involve real life examples of stocks and having us do questions helped the info sink in even more!

    This site in general is like the golden key to trading :)

  10. Mohammed:
    July 16, 2014 at 2:14 pm

    -do you know how to configure a two line bollinger band insteand of three by default
    -also need to know the link to download EMA
    -I need MACD where the buy and sell signals are displayed by a curved color pattern. i was using one and now i forgot where i downloaded it. in simple terms, when the curve turns blue simply buy when the dotted lines confirm up moves and when turns red, sell when the dot red line confirm down trend

    Mohammed

  11. Sha:
    August 15, 2014 at 2:27 am

    Hi Mr.Chris (My FX Coach),

    The above article is clear to understand. But, the confirmation & continuation signals are the ones which are quite difficult (confusing) to understand. Mainly, because they are in the Middle Band region and since it is in Middle Band, it could be retesting the Middle Band or breaking away from the Middle Band, how can a novice trader consider continuation and confirmation as a trade setup? I know we can consider the close price to determine the direction. But, going back on some charts and seeing such signals – it proves to be quite a tricky setup with 50-50 chance. Are there any specific conditions/advice when continuation/confirmation signals are to be considered? How can we differentiate retesting and continuation/confirmation (such an article would be great!)

    Thank you once again Coach!

  12. ash:
    August 26, 2014 at 12:41 pm

    wow Chris what an article !! just wish i could have read this earlier before i was asking all sorts of silly questions in the other articles !

  13. Timothy:
    September 6, 2014 at 10:22 pm

    Hey Chris my confidence in trading confidently increases by every article of yours I read even without paying a dime
    More grease to your elbow and more assets in your arsenal,you did quite well and God will bless all your pips
    Thanks.

  14. Saeed Afridi:
    September 13, 2014 at 2:05 pm

    I am new forex trader and start trading right now. as a learning /student of FX trading your article about bollinger-bands is fantastic. Explain in a very simple and more efective ways. although i am new in trading and needs some more time and experince to understand other things….but this article is very good and appreciate to Mr. Chris Pottorff for a such a nice article which specially very helpful for New trader….

    I will apply this technique in my trading

  15. Antonio Gonzalez:
    September 14, 2014 at 4:29 pm

    Hello Chris.

    In certain platform (Sirix) when I asked the system to add Bollinger Bands to the chart I was presented with the option of “Field” (to construct the BB) with these choices: Open, Close, High, Low and TrueRange. Which one should I choose to have exactly the Bollinger Bands you are using to trade?

    Thanks in advance for your answer!

    Cheers,

    AJ

    • September 14, 2014 at 10:30 pm

      Hi Antonio, You should choose the “Close”.

      • Antonio Gonzalez:
        September 14, 2014 at 11:28 pm

        Ok. Thank you very much Chris.

        Cheers,

        AJ

        • September 15, 2014 at 5:42 am

          You are welcome.

  16. rezze:
    October 15, 2014 at 1:29 pm

    Hi Chris,

    What time frame is suitable? what are story behind each different time frame using bollinger band? or is there any situation which should we refer to the time frame?

    Thank you
    Rezze

  17. Angus:
    November 26, 2014 at 8:21 pm

    Hi Chris,

    It’s me again. You know I have got it, when I ask less questions. But at the moment, like a sponge I am absorbing your materials. I can’t believe you wrote so many articles. And they are all good and consistent.

    Referring to point 2 above on reversals.
    1. Does it matter to the strength of the setup if in the piercing line above, the upper shadow is also very long. Isn’t this a sign that the bear is also pushing price down?
    2. What if both candles with beautiful size and long shadows were out of the BB range, and none made back or crossing into the BB range? What do you make out of the strength of such a setup? Do you wait for another confirmation?

    Thanks

      • Angus:
        November 28, 2014 at 2:46 am

        What about the chart in the article above on “1. Trend Trading”. GBPUSD.

        What if the candlestick preceeding #1 was also outside the BB range? Say it went bearish body and shadows under the lower BB, and candlestick #1went up bullish strongly but still outside the lower BB? Would it have been a good 100 setup?

        • November 28, 2014 at 10:31 am

          Yes.

        • Angus:
          November 29, 2014 at 6:32 am

          Hi Chris,

          I found a semi perfect example of what I was talking about.

          GBPCAD on 2014.09.07 and 2014.9.08; both of them are outside the BB range. Is this a strong trade setup? What would you score it?

          Thanks

          • November 29, 2014 at 3:35 pm

            Hi Angus,

            Yes, it a 100 score trade setup that we took it and we use it to compare the other short trade setups with:
            http://www.fxkeys.com/typical-example-of-a-strong-dark-cloud-cover-pattern-formed-on-gbpcad-daily-chart/

            It seems you have not read the articles I have listed in my 5 easy steps article, otherwise you would have seen the above GBP/CAD article. I suggest you to read all the articles listed on the below post carefully and patiently. What I understand from the number of questions you ask while you have not read the articles carefully, is that you are excited and in a hurry. This is not good for a forex trader:
            http://www.fxkeys.com/become-a-profitable-forex-trader-in-5-easy-steps/

            • Angus:
              November 29, 2014 at 7:00 pm

              Hi Chris,

              Thank you for your wisdom. I really appreciate your helpful attitude and being extremely patient with me.

              You are right that I am excited and in a hurry to understand it. But I definitely don’t want to rush trading with real money until I am very comfortable. I too have lost a lot of money, and we are not talking about just tens of thousands. In fact, I had decided to not trade again but to just invest using value investing. But I still got burnt on good companies because of there are just too many variables, e.g. company directors’ personal issues, product defects, etc. Hence, I find currencies are much purer. And the market size is so large that it is not easily manipulated.

              Having said that, I have actually read so many of your articles. Including the one you mentioned above. But because I read so much, whilst I may remember the pattern, I may not remember the currency pair and the dates.

              Chris, your article http://www.fxkeys.com/typical-example-of-a-strong-dark-cloud-cover-pattern-formed-on-gbpcad-daily-chart/ talks about bearish entry on 2014.08.06. I am actually talking about a bullish entry on 2014.09.07 and 2014.9.08 on GBPCAD daily chart. Are you talking about the same thing?

              You did go long on 2014.09.07 on GBPCAD but only based on weekly chart, and not daily. This is question was to illustrate whether a breakout where the candles are still outside the range (and not making it back into the BB range) can still be considered as a strong trade?

              Now, you are right about not too hurry it up, and read up the articles patiently. A very important advise. I promise to remind myself on that. I am trying to do backtesting now, and see what the outcome is.

              Thank you for your time, help, and patience. God Bless!

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