Learn Forex: Bollinger Bands

The main purpose of Bollinger Bands® is to help traders determine whether assets are reasonably priced, and whether prices in the market are stable or may be moving toward different levels. This information can be potentially helpful for investors because it can determine the following: whether they are paying a fair price for the asset, whether it is too costly, or whether it is a bargain purchase that could result in profit in the future.

Bollinger Bands® are not recommended as an exclusive method for understanding price movements. However, they are considered an effective tool for analysing price movements among several other tools. Those include basic trend analysis and indicators such as stochastics, moving average convergence and divergence, wave patterns and price gaps.

Bollinger Bands® were developed by John Bollinger in 1983, and they’re a system under a registered trademark.

The upper and lower band lines are based on a standard deviation of the price from the moving average. Standard deviation is a mathematical measurement for how spread out a group of numbers is on average. In the case of Bollinger Bands®, the numbers involved are prices.

On most analysis systems, traders can change the periods, and thus the standard deviation, used in the calculation of the bands according to their preferences for trading time horizons.
The region between the upper and lower bands is often referred to as an “envelope.”

Using Bollinger Bands®

A price trend that remains narrow and in the direction of either the upper or lower band line is considered to be a strong trend.

Analysts pay particular attention to when prices are trending near the upper or lower bands. Prices that are near the upper band are considered to be “overbought,” and good prospects for selling. Similarly, prices that are near the lower band are considered to be “oversold,” and good prospects for buying.

Signals: Trading Tops And Bottoms

The Bollinger analysis system uses visual patterns to determine when the market has reached a high or low price. Some of the main “signals” for price trends are patterns that come in the shapes of the letters “W” for market price bottoms and “M” for tops. When a price of a given asset reaches a low on the chart, chartists look for repetition of that low at the second bottom on a “W” shape for confirmation that the price will not likely go lower.

The middle price peak before the second downward trend on the “W” pattern is understood to be the “breakout” point. If the price rebounds above this point following the second low of the “W” shape, then the price is understood to have broken out of the downward trend and initiated a trend on a new upward movement.

The same type of analysis holds for determining the top of a price trend, only in an inverted manner. If an upward movement falls from a peak, analysts look for a second repetition of the peak in an “M” shape. When the price falls to below the middle “breakout” point in a second downward movement on the “M” shape, the price is determined to be on a new downward trend.

The fact that a price breaks beyond the upper or lower Bollinger Band® is not necessarily considered a “signal” of a possible new price movement. Analysts note that prices can frequently trend along the lines and break out on occasion When this occurs, the movement is called a “tag,” and it is considered to indicate that a price is at a high or low within a shorter term price trend. However, it has been seen that frequently when a price breaks the upper or lower band, it will fall back within the band toward the mid-line.

Volatility Trends

Bollinger Bands® are also used for examining the potential volatility of the market. In particular, when the band “envelope” narrows significantly, it is considered to be a sign that volatility will soon increase. This can be helpful in cueing investors that buying or selling opportunities may be approaching.

Other Indicators

In addition to using Bollinger Bands® as a tool on their own, they are frequently used with other indicators such as momentum, volume, sentiment, open interest and inter-market data.

RSI

One particularly popular indicator for use with the Bollinger Bands® is the Relative Strength Index (RSI), a “momentum oscillator” developed by J. Welles Wilder Jr. The RSI is used to compare upward movements in closing prices to downward movements over a selected period of time. Like other charting techniques, this index can be used to find signals that could determine bull market trends, bear market trends, trend reversals and large price corrections.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. Kaf will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

Category: Forex Indicators

Learn Forex: Pivot Points

Pivot points are technical indicators that can prove helpful to investors, giving them one more tool for assessing the market. Trend, range and breakout traders can all harness pivot points points, using them to determine when to enter and exit positions.

By calculating these points, investors can gather several helpful pieces of information. Technical analysts can use pivot points to not only determine levels of support and resistance, but also to gauge whether a market is bearish or bullish. In addition, these points can be especially helpful for determining stop-loss prices and profit targets.

At their most basic level, pivot points are areas where a security’s price trend might change. These technical indicators can help one obtain a better sense of how these financial instruments will behave in the short term, and investors frequently use pivot points for this specific purpose.

Calculating Pivot Points

To calculate pivot points, technical analysts harness the high, low and closing value of a security, and in some cases levels of support and resistance. These values can be from the last day, week or even month. The forex markets are open 24 hours a day, so calculations that involve a particular session will assume the session ends at 5 p.m. EST.

There are several methods for determining a pivot point, with the most basic one involving averaging the high, low and closing prices for the prior day. Another technique, called the five-point system, adds two support levels and two resistance levels to the aforementioned price levels.

Once a trader has identified the pivot point, he can then use this piece of information to calculate support and resistance levels. To determine the first levels of support and resistance, the trader can start with the pivot point and then measure the width between this point and either the high or low prices from the previous day.

To calculate the second level of support and resistance, the investor can utilise the full width between the prior session’s high and low prices.

Using Pivot Points

Once traders have identified pivot points, as well as their corresponding levels of support and resistance, they can harness this information. There are many uses of these data points, with some being more straightforward than others.

One basic application is that if a currency is trading above a pivot point derived from the previous day’s values, this situation helps show the bullish feelings of the global markets. In such a case, a forex trader looking to make use of trends might want to take a long position in the belief that he can capitalise on the sentiment of the market.

However, if a currency is trading below the prior session’s pivot point, an investor can take this as evidence of bearish sentiment. In cases like these, a trader may want to take a short position on the currency.

Range Trading

Range traders can potentially use pivot points, as well as their corresponding levels of support and resistance, to find better times to enter and exit trades. For these investors, pivot points can serve as reversal points. In addition, support levels can provide a good place to enter a buy order. Once a currency nears one of these levels, a range trader might find it a good time to take a long position.

In contrast, resistance levels can help give investors a good place to sell. When a currency approaches such a level, this might indicate an opportunity to close out a position and take profits.

Breakout Trading

Investors interested in breakout trading can also make use of pivot points. More specifically, these traders, who study charts in an attempt to identify instances where a security will experience a significant price fluctuation in a short time frame, can use pivot points to gauge when breakouts are genuine.

If used effectively, pivot points can potentially be a valuable tool for traders. If investors take the time to learn about these points, they may find they have one more tool for evaluating the market and determining when to enter and exit positions.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

Category: Forex Indicators

What Is Momentum Trading?

Momentum trading is a technique in which traders buy and sell according to the strength of recent price trends. Price momentum is similar to momentum in physics, where mass multiplied by velocity determines the likelihood that an object will continue on its path. In financial markets, however, momentum is determined by other factors like trading volume and rate of price changes. Momentum traders bet that an asset price that is moving strongly in a given direction will continue to move in that direction until the trend loses strength.

Where Did Momentum Trading Start?

The practice of momentum trading has been around for centuries. As early as the late 1700s, famed British economist and investor David Ricardo was known to have used momentum-based strategies successfully in trading. He bought stocks with strong performing price trends, and then sold stocks whose prices were performing poorly. He characterised the method with the phrase: “Cut short your losses; let your profits run on.”

However, the concept was obscured and left dormant following the development and popularisation of value investing theory from the 1930s onward. Investors would focus more on the intrinsic, or “fundamental,” value of an asset, and less on the trajectory of the movement of its price.

Relative Momentum And Absolute Momentum

Momentum trading can be classified in two categories: Relative momentum and absolute momentum.

How Is A Momentum Strategy Employed?

Momentum can be determined over longer periods of weeks or months, or within day-trading time frames of minutes or hours.

The first step traders customarily take is to determine the direction of the trend in which they want to trade. Using one of several momentum indicators available, they may then seek to establish an entry point to buy (or sell) the asset they are trading. They will also want to determine a profitable and reasonable exit point for their trade based on projected and previously observed levels of support and resistance within the market.

Additionally, they are recommended to set stop-loss orders above or below their trade entry point—depending on the direction of the trade. This is in order to safeguard against the possibility of an unexpected price-trend reversal and undesired losses.

Momentum Indicators

The momentum indicator is a common tool used for determining the momentum of a particular asset. They are graphic devices, often in the form of oscillators that can show how rapidly the price of a given asset is moving in a particular direction, in addition to whether the price movement is likely to continue on its trajectory.

The notion behind the tool is that as an asset is traded, the velocity of the price movement reaches a maximum when the entrance of new investors or money into a particular trade nears its peak. When there is less potential new investment available, the tendency after the peak is for the price trend to flatten or reverse direction.

The direction of momentum, in a simple manner, can be determined by subtracting a previous price from a current price. A positive result is a signal of positive momentum, while a negative result is a signal of a negative momentum.

Momentum tools typically appear as rate-of-change (ROC) indicators, which divide the momentum result by an earlier price. Multiplying this total by 100, traders can find a percentage ROC to plot highs and lows in trends on a chart. As the ROC approaches one of these extremes, there is an increasing chance the price trend will weaken and reverse directions.[6]

Here are a few of the technical indicator tools commonly used by traders to track momentum and get a feel for whether it’s a good time to enter or exit a trade within a trend.

Risks To Momentum Trading

Like any style of trading, momentum trading is subject to risks. It’s been found to be successful when prices follow on a trend, but on occasion momentum traders can be caught off guard when trends go into unexpected reversals. Traders should remember that:

Summary

Momentum is a key concept that has proven valuable for determining the likelihood of a profitable trade. Measurements of momentum can be used in the short and long term, making them useful in all types of trading strategies. Several technical trading tools are available to reveal the strength of trends and whether a trade on a particular asset may be a good bet.

However, traders should be forewarned that momentum projections are customarily calculated using measurements of past price trends. Actual momentum and price can change at any moment based on events that weren’t factored into the original calculations. Because of this, it’s important to take preventative measures, such as setting stop-losses, to safeguard against unforeseen price reversals in even the most probable momentum scenarios.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

Category: Forex Indicators