Bollinger Bands are named after John Bollinger, the man who created this particular technical indicator, and it is quite a popular indicator amongst forex traders. This indicator can be applied to your price chart and it is basically two bands / envelopes (and a middle band) that are based on a moving average and a standard deviation. The default setting uses a 20 period moving average and a standard deviation of 2, but you can adjust these settings to whatever you want.

It is essentially a measure of volatility because these bands / channels widen as the markets become more volatile, and narrow when they are becoming less volatile. This is why they are generally very narrow during the quieter overnight session, and significantly wider when the major markets open and important economic figures are announced.

If you take a close look at this Bollinger Bands indicator, you will see that the price is nearly always within the two outer bands. Indeed I think I remember reading that it is within these two bands around 95% of the time. So it can sometimes be a profitable strategy to go short or exit existing long positions when the price touches the upper band, and vice versa when it touches a lower band.

However I personally think a better strategy is to wait until the Bollinger Bands indicator consists of two very narrow lines, indicating a quiet period of consolidation, and then wait for the price to break decisively and close above or below one of these lines, indicating that a new breakout is under way. The longer these bands remain very narrow, the more chance there is of a big breakout taking place.

This is particularly effective when you use one or two other indicators for confirmation, and as with any strategies, tends to work better on the longer time frames.

For example if you look at the weekly chart of the GBP/USD pair, you can see that the price doesn't move outside of the two outer bands very often. However when it does you often get some big breakouts, like in August 2008, and to a lesser extent May 2009 and February 2010.

So should you start using Bollinger Bands yourself?

Well that is entirely up to you of course. However I have to confess that this is not an indicator that I personally use myself. I know a lot of traders find it very useful, but I have never found it to be that beneficial overall and much prefer to use various other indicators instead.

If you are currently using it yourself, I would love to hear from you and learn how you are using it as part of your overall trading strategy.