Ask the Experts: How do I spot trend reversal using Bollinger Bands?

In the last post of the Ask the Expert series, Scott Boyd and Dean Popplewell began chiseling away at a question we received about spotting trend reversal.  Today they will focus on another facet of trend reversal: using Bollinger Bands.

Traders have long understood the relationship between volatility and trends. Volatility – that is, the degree by which an exchange rate varies over time – tends to increase as a market trend gathers momentum. This is because traders are buying and selling in greater frequency as they attempt to get in on the trend. However, as the trend nears the end of its run and traders slow their activity, volatility naturally declines.

Because volatility provides immediate feedback on the level of market activity, it is an important technical indicator. One of the most common methods of measuring forex volatility is through the use of Bollinger Bands placed over a price chart as demonstrated below:

Bollinger Bands show changes in market volatility through the width of the two bands formed by the three lines, and the more volatile the currency pair price, the wider the bands grow. In the example above, you can see the bands widening as the price decreases until it reaches a point where the bands suddenly narrow. This indicates that volatility has quickly tailed off which means that market activity has reduced.

Coming as it does following a price decline, this is a strong indication that the rate is likely to increase as market participants consider the new market price. If the price finds support and buyers come in at the current price, the bands will widen in response to the increased activity.

You can learn more about Bollinger Bands on the OANDA fxTrade website.

Next time we’ll continue discussion of spotting trend reversal by looking at different price patterns. Okogba Papa Woyin-Emi (who sent in this question via Facebook), you have been keeping our expert panel busy answering this one! Have questions for Scott and Dean? Send them to us via Facebook and Twitter. We are excited to see what you come up with.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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