Bollinger Bands and breakouts
The FX market is in a constant state of fluctuation between a range bound and trending condition.
In a range bound environment, the buyers and sellers continue to focus their
attention to recent high and low prices with the hopes that this current range
will persist in the near future. On the other hand, a trending market can be
identified as one that extends to an overwhelming degree to one direction or the
other; higher or lower. Once we have identified the current market condition,
there are a number of rather simple steps we may take to take advantage of
future potential moves. However the difficulty may lie in the transition period
between one market condition and another. For that reason, we may employ the use
of a secondary indicator such as the Bollinger bands to help differentiate
between the two.
For example, the following chart shows
the market as it first remains inside its two respective Bollinger bands as well
as its predefined trading range. Eventually this trading range breaks out to a
new high as an upward trend now begins. This can be seen very easily in with the
use of the Bollinger Bands. At times the market may drift below the lower band
and above the upper band, only to return back inside its predefined range.
However this breakout is marked as the subsequent candle breaks and closes above
the upper band. This additional sign of strength now tells us the likelihood of
a new uptrend increases dramatically, and put the probabilities of success in
the anticipation this new trend and higher prices to come.
Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading.