Tuesday, January 5, 2010

Tips Forex by Jhon Bollinger - “Understanding volatility is key to success in trading.”

The name Bollinger has become a household word in the financial world for one simple reason: His namesake bands have become ubiquitous. John Bollinger first conceived of Bollinger Bands while trading options where volatility is of pivotal importance. Price may be nearly impossible to predict, but volatility follows a familiar pattern. Periods of high volatility are interminably followed by periods of low volatility like the rhythm of giant waves crashing on the beach after a cyclone.

Frustrated by trying to use static bands to contain price action and the constant subjective redraws and the risks of self-deception this practice entailed, he set out to design a solution that would automatically adjust to the ever-changing volatility tides. In 1983, Bollinger Bands were born.

Bollinger is the president of the financial advisory firm Bollinger Capital Management, the founder of BollingerBands.com, a regular guest on CNBC and the author of Bollinger on Bollinger Bands (2001). The book is translated into seven languages.

Although the concept of volatility is of supreme importance in options markets (all options are priced ased on a combination of implied and historic volatility), it cannot be ignored in any market a point often overlooked by traders and investors. And based on recent market action, it is a lesson that many have had to learn or relearn the hard way. Here is how he uses volatility along with his two key indicators to recognize tradable patterns and the best time to enter and exit the trade:

“The purpose of all trading bands is to provide a relative definition of high and low. By definition, prices are high at the upper band and low at the lower band. Bollinger Bands facilitate that definition in an adaptive manner by referencing volatility. %b tells us where we are in relation to the Bollinger Bands. Derived from the formula for stochastics, %b equals 1 at the upper band, 0.5 at the middle band and 0 at the lower band. The formula is %b = (last - lowerBB) ÷ (upperBB - lowerBB).

“The indicator %b has many uses in trading systems; one of the more interesting is in pattern recognition. With %b, one can compare price relative to the Bollinger Bands and absolute price levels in a rigorous manner. Suppose we have a ‘W’ bottom with the first low at $45 and the second at $43. Most people will only see the absolute new low and will ignore the pattern. However, if the second low sports a higher %b reading than the first, we have a new absolute low, but not a new relative low, which is an actionable divergence. All we need is confirmation to trigger the entry.”

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