Part 2 Creating the first Forex strategy – Bollinger bands

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Part 2: Creating the first Forex strategy – Bollinger bands

In our previous part and numerous articles at our website, we have described how to design an effective trading strategy. Let’s look for some inspiration! I will show you techniques that you can completely take over or use to improve your current trading strategy by filtering loss-making trades.

Trend vs. sideways movement

The first fundamental question is “Will my strategy work when trading with or against the trend?”

  • Trend trading is more tempting as it offers bigger gains. Many traders find this way of trading as “more natural”. The next step is to decide whether one should trade with the trend or against.
  • Sideways trading is more typical because the market moves in the same direction. RSI or Stochastic represent two of many indicators in sideways trading.

It’s up to you to decide which way to go. However, there is one thing you must know: Is the market in trend or is not. As you can guess, trend strategies will only work in trend and vice versa.

Phases of market movements

Bollinger Bands and Moving Averages

The indicator is known as “Bollinger bands” uses as a base MA (moving average). In this combination, each indicator has a different meaning. If you use a moving average, let’s say with a period of 50, you will see the present trend. The situation in which moving average is going down and the prices in the chart are below the moving average represents a downward trend. MA going up with the market above the moving average line indicates an upward trend.

Determining a trend by using the above rule can also be applied as a filter for other trading trend and non-trend strategies If you trade in daily or weekly cycles you will need a longer period such as 200. Traders holding a position for a couple of seconds and minutes will do with 30.

Opening of trade: Bounce from MA in a downtrend market.

By adding Bollinger bands to the moving average you can create a simple trading strategy. Bollinger bands show when the market “takes a rest” moving sideways. At this moment, the instrument tends to get closer to the middle band of the Bollinger bands to react. You can speculate that after a minor retracement the trend will continue.

Modification of trading strategy

Got an idea and trading plan? Now it’s up to you to carry on. You have been shown the fundaments of a trading strategy but the most relevant factors for your success are the instrument, time band and, most importantly, position management. Position management is the very fundament on which other things are built.

Option 1: When opening a position you can place the stop loss and take profit orders on the upper and lower Bollinger bands. Option 2: To leave the stop loss and take profit orders floating at the level of the newly created Bollinger bands. Option 3: Open with an X volume and close only a half (i.e. X/2) of the position at the level of Bollinger band (in profit), to continue working with the second half (to move stop loss to open position and to use take profit for speculations over the formation of a trend or, to set floating stop loss at the level of Y pips from the top profit).

Further information on how to work with the stop loss / take profit orders can be found in our articles, category: Forex money management.

The idea of using Bollinger bands as a core of your trading strategy is the easier part. More difficult is to correctly set up the strategy, which requires a thorough test. Give yourself a whole day (can be one over a weekend), look at a chart showing history, draw a few indicators in it and perform a back-test. This procedure is universally applicable to Forex, commodities, shares as well as binary options. To develop a Forex trading strategy takes a few hours. No pain, no gain. Performing the back-test will help you better understand the strategy.

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Those who expect from this article a concrete strategy should not ignore the fact that markets evolve and that it is necessary, from time to time, to adjust the stop loss and take profit orders. If your ambition is to be a serious trader you will (using the above advice) surely find your own trading style. We will appreciate if you share with us your achievements and ideas for improvement in our comments section.

Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

Double Bollinger Band® Strategy to Trade Forex

The Double Bollinger Band® strategy has a wide variety of applications but provides the most value when assessing the momentum and volatility of price action. It allows traders to pinpoint entries and exits as well as identify when a trend is maintaining or losing momentum.

Keep reading to discover:

  • What is a Double Bollinger Band® strategy?
  • How to trade forex with Double Bollinger Bands®
  • Advantages and limitations of a Double Bollinger Band® strategy
  • Further reading on Bollinger Bands®

This article assumes the reader has a basic understanding of Bollinger Bands®. If you’d like a refresher, read our guide to Bollinger Bands® in forex trading .

What is a Double Bollinger Band® Strategy?

The Double Bollinger Band® Strategy makes use of two Bollinger Bands®in order to filter entries and exitsin the forex market. The strategy aims to enter long (short) trades when price breaks above (below)one standard deviation. The strategy can be applied to ranging markets, as a breakout strategy or when assessing the momentum/slowdown of an existing trend.

Add the following indicators to the desired market/security:

  1. Default Bollinger Band® (20 2). The first number relates to the simple moving average and the second, to the number of standard deviations from the mean/average.
  2. A second Bollinger Band® (20 1). Select the default 20 SMA but this time use the setting with only one standard deviation.

Before getting into the strategy, it is crucial to understand how to interpret the chart below as there is a lot to take in.

Dissecting the chart is easiest to do by starting at the middle and working our way outwards. The dotted line in the middle is the moving average. Then moving out in both directions, the green and red lines represent the single standard deviation, while the outermost lines (in black) represent the two standard deviations.

Statistically speaking, 95% of the observed candles should be contained within the two standard deviations, meaning traders will witness price moving within or across the various segments, triggering many signals.

The Double Bollinger Band® strategy incorporates three different zones.

  1. Double Bollinger Band ® (DBB) Buy Zone : This is the light blue area between the first standard deviation and the double standard deviation that is found above the 20 SMA. Presents a buy signal.
  2. DBB Neutral Zone : This is the purple area between the upper and lower, single, standard deviation. Price trading in this area could be indicative of a choppy market that lacks a directional bias. Trend traders are to avoid taking new positions in this zone. Signals a slow- down in momentum or the beginning of a ranging market.
  3. DBB Sell Zone : This is the light blue area between the single standard deviation and the double standard deviation that is found below the 20 SMA. Presents a sell signal.

All three zones can be seen in the chart below:

How to Trade Forex with Double Bollinger Bands®

The two main strategies to employ using Double Bollinger Bands® involve breakouts and trend trading and will be explored below.

Double Bollinger Band ® Breakout Strategy

The Double Bollinger Band® strategy can be applied when trading breakouts of an existing trading range by observing a break above/below the range; combined with a strong break into the DBB buy zone or DBB sell zone. Witnessing strong breaks provide a greater bias in favour of the breakout as traders look to avoid a false breakout.

Below is an example of a Double Bollinger Band® breakout scenario in the EUR/GBP chart. Towards the end of the range there is a break above the upper band of the single, standard deviation (green line) however, price hadn’t moved high enough to break out of the range. Traders should be looking for price to break out of the range and into the DBB buy zone, with strong momentum.

When looking for further confirmation, traders can view that the break occurs during a new expansion of the Bollinger Bands®, after a period of relatively low volatility (contracting Bollinger Bands®).

The large green candle, pointed out below, provides the necessary confirmation of a breakout and presents a strong buy signal. To mitigate risk, traders can place stops at the 20 SMA with targets set at key levels of resistance all while maintaining a positive risk to reward ratio .

Double Bollinger Trend Trading Strategy

The Double Bollinger Band® trend trading strategy allows traders to assess the momentum of an existing trend. It allows traders to exit on a slow-down or add to existing positions when momentum and volatility increase.

The example below takes a look at the same EUR/GBP chart after the breakout where the currency pair began trending. Price broke above the upper band of the single standard deviation and even breached the upper band of the uppermost line – representing two standard deviations.

Such momentum and volatility in the DBB buy zone presents a buy signal and the Double Bollinger Band® can be used to track the progress of this new uptrend.

As long as price remains between the buy zone and the 20 SMA (dotted mid-line), traders can maintain the long bias. The exit point can either be on a close below the mid line or a breach of the neutral zone into the DBB sell zone, depending on the level of risk tolerance. Those using the mid-line as a stop can manually move their stops along the 20 SMA as price rises.

Advantages and Limitations of a Double Bollinger Band® Strategy

There is no such thing as a strategy that works all of the time. Bearing this in mind, traders should be aware of the advantages and limitations of the Double Bollinger Band® strategy.

Advantages Limitations
Low volatility often precedes bigger moves. Having a double Bollinger Band allows traders to assess the degree of volatility when analyzing a potential trade Large moves into the buy and sell zone can reverse. Hence, risk management is key
Clear entry and exit signals
Easy to identify the momentum of current trend

Further reading on Bollinger Bands®

  • Bollinger Bands® provide traders with a visual representation of volatility in the market. Learn how to apply this indicator when trading forex with Bollinger Bands® .
  • The Bollinger Band and MACD strategy combines Bollinger Bands® with the MACD indicator to provide traders with insight into volatility, direction and momentum.
  • Find out what other indicators can be used to assess volatility in our guide to technical indicators defined and explained for forex traders .

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

How are Bollinger Bands used in forex trading?

Bollinger Bands are popular with technical analysts and traders in all markets, including forex. Since traders of currency look for very incremental moves to profit, recognizing volatility and trend changes quickly is essential. Bollinger Bands help by signaling changes in volatility. For generally steady ranges of a security, such as many currency pairs, Bollinger Bands act as relatively clear signals for buying and selling. This can result in stop-outs and frustrating losses, though, so traders consider other factors when placing trades in relation to the Bollinger Bands.

Setting Limits

First, a trader must understand how Bollinger Bands are set up. There is an upper and lower band, each set at a distance of two standard deviations from the security’s 21-day simple moving average. Therefore, the Bands show the volatility of the price in relation to the average, and traders can expect movements in price anywhere between the two bands. Forex traders can use the bands to place sell orders at the upper band limit and buy orders at the lower band limit. This strategy works well with currencies that follow a range pattern, but it can be costly to a trader if a breakout occurs.

Reading Volatility

Since Bollinger Bands measure deviation from the average, they react and change shape when price fluctuations increase or decrease. Increased volatility is nearly always a sign that new normals will be set, and traders can capitalize using Bollinger Bands. When the Bollinger Bands converge on the moving average, indicating lower price volatility, it is known as “the Squeeze.” This is one of the most reliable signals given by Bollinger Bands, and it works well with forex trading. A Squeeze was seen in the USD/JPY currency pair on Oct. 31, 2020. News that the Bank of Japan would be increasing its stimulus bond-buying policy sparked the trend change. Even if a trader did not hear about this news, the trend change could be spotted with the Bollinger Band Squeeze.

Backup Plans

Sometimes reactions are not as intense, and traders can miss profits by setting orders directly on the upper and lower Bollinger Bands. Therefore, it is wise to determine entry and exit points near these lines to avoid disappointment. Another Forex trading strategy to work around this is to add a second set of Bollinger Bands placed only one standard deviation from the moving average, creating upper and lower channels. Then, buy orders are placed within the lower zone and sell orders in the upper zone, increasing execution probability.

There are several other specific strategies used in currency trading with Bollinger Bands, such as the Inside Day Bollinger Band Turn Trade and Pure Fade Trade. In theory, these are all profitable trades, but traders must develop and follow the methods exactly in order for them to pan out.

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