How can Bollinger Bands be Used for Trading?

Bollinger bands are typically used by traders to detect extreme unsustainable price moves, capture changes in trend, identify support/resistance levels and spot contractions/expansions in volatility. There are a number of ways to interpret Bollinger Bands.

Breakouts

Some traders believe that when the prices break above or below the upper or lower band, it is an indication that a breakout is occurring. These traders will then take a position in the direction of the breakout.

Overbought/Oversold Indicators

Alternatively, some traders use Bollinger Bands as an overbought and oversold indicator. As shown in the chart below, when the price touches the top of the band, traders will sell, assuming that the currency pair is overbought and will want to revert back to mean or the middle moving average band. If the price touches the bottom of the band, traders will buy the currency pair, assuming that it is oversold and will rally back towards the top of the band. The spacing or width of the band is dependent on the volatility of the prices. Typically, the higher the volatility, the wider the band and the lower the volatility, the narrower the band.