Contracting bands warn that the market is about to trend: the bands first converge into a narrow neck, followed by a sharp price movement. The first breakout is often a false move, preceding a strong trend in the opposite direction.
A move that starts at one band normally carries through to the other, in a ranging market.
A move outside the band indicates that the trend is strong and likely to continue unless price quickly reverses.
A trend that hugs one band signals that the trend is strong and likely to continue. Wait for divergence (when the price is flat or rising or falling, but the MACD is going in the opposite direction...the price will break out in the direction of the MACD) or a Momentum Indicator to signal the end of a trend.
I use the BB's for indication of when a breakout or breakdown is imminent. When the outside bands get very narrow, it means the price is consolidating and is getting ready for a breakout, either up or down.
At this point, it's dangerous to have a position because you don't know if it's going to break up or down. When the bands get very narrow, it's almost better to close out your old positions, even at a loss, until you see a clear direction. If you don't want to close out an old position at a loss, at least hedge it. See more about hedging later in the Advanced Day Trade Forex course.
The BB's can't tell you which direction the breakout will be, the Chaos Oscillator (MACD) and Momentum will do that, and I always trade in the direction the Momentum and Chaos (MACD) are going.
Sometimes when using the slower timeframes, I use the outer BB's as targets for my limit sell price. If the bands are really wide after a big move, I use the middle band as my limit target price.
Bollinger Bands are designed to capture the majority of price movement. When prices move beyond the upper or lower band, they are considered high (overbought) or low (oversold) on a relative basis.
More On Using Bollinger Bands:
First, the BB's can be used as I mentioned before, as price targets. If the bands are narrow, the price will be jumping up & down within the two outer bands. As mentioned before, this is not the best time to be putting on a trade, as the trading range is too narrow, unless you can make a decent quick profit in a 1 or 5 minute chart.
If the range isn't too narrow, you can ride it up and down and book pips. I only attempt this in a 1 or 5 minute timeframe using the 5/9/18/50 EMA's. Don't do it if you can't make at least 5-10 pips up and down. The danger is in whipsaws.
Most of the time, unless the bands are too narrow, you can make trades by literally bouncing off the outer bands.
This is called "The Bollinger Bounce".
When placing a trade, just set your stop at the outer BB and your price target limit sell order where the other outer band is.
If your trade rapidly approaches the limit price and all your indicators say that the price movement is just getting started & not likely to quickly reverse on you, then you should first either remove your limit price & let the price run, or, raise your limit price another 5-10 pips. Then raise your stop to either your entry point or past it, to lock in either breakeven or some profit in case the price suddenly reverses on you.
This is definitely what you should do in a price breakout. If the price keeps going up in an extended breakout, you just keep adjusting your stop upwards to lock in more profit (this is called a trailing stop, more later on this subject) and keep raising your limit also.
A Super Advanced method of using BB's is to use two sets of BB's, both with the middle band set at 18. Set one BB to a standard deviation of 3 and leave the other standard deviation at 1. This gives you 6 short term support/resistance lines to work with. Your initial stop and target are the outer bands, and your inner bands are used for your trailing stop and short term resistance and support. You can also trade off the two inner bands.
This method is very similar to using Fibonacci OR Average True Range (ATR), but is much easier to use and understand.
by Cynthia Macy