Bollinger bands are designed to signal a trend continuation or reversal, and when used to work off the center line breaks, rather than trading the outer band action, can be a good secondary confirmation of potential price action to come. As a stand-alone indicator they sometimes struggle to keep up with price action, but on a daily chart, and with the right outlook, they can be very reliable.
Once the outer bands are violated one of two things will happen; there is a continuation of the current trend and direction, or a reversal to the center line takes place. Looking for the center line to be broken after a reversal off the outer bands tends to indicate that a continuation to the opposite outer band will happen.
The review below uses Aud/Usd Bollinger bands to signal that the currency pair is ready to drop lower if sentiment changes, and then looks at a correlated market (S&P Futures) for secondary confirmation that whatever is driving aussie value (global risk tolerance) is also showing itself in the main risk market (equities).
The follow through will be subject to global equity markets moving into the red, and reversing some of the 50-60% gains made since March 2009 when the Federal Reserve stepped in to further strengthen the weakened credit and liquidity markets. The last week in September has a poor record of performance, and is one of the worst performing weeks of the year, and as we can see below, the daily charts are already signaling a move lower may be coming.
TheLFB Daily S&P Futures Chart
The price action has struggled to move higher on the above S&P daily chart since initially violating the outer band at 1070 and the reversal to the center line has taken seven session to complete. Now it is getting tested, and bearing in mind that the last week in September is a poor week for equity trade historically, the market may break that support (and center line) at 1035. If so the likely target will be somewhere around the opposite Bollinger band; in the 1000 area if fundamentals allow.
The market will not move there because of the Bollinger band, the area is indicating where the next likely price point of importance is going to be, with possibly plenty of stops on the way. The momentum of the break of the center line may however make that test a lot more likely than some may think.
The above aussie chart shows a similar set-up to the S&P Futures view, and replicates the sideways movement since touching the outer bands that has allowed the center line to play catch-up, and now create a price point area that needs to hold as support. The momentum of a break of the 0.8550 area will not only break the center line, it will be a break of the bottom of the price channel formed over the last week of trade. The entry and target areas are clearly seen, it will just now be down to market mechanics, and equity and commodity markets dropping lower, for this technical outlook to be confirmed as viable.
This set-up is covered in full as part of TheLFB on-line Technical Trading Course, that puts into action, and creates a trade plan to identify, monitor, and trade these set-ups. The Signal Service will be monitoring this play during the early part of this week, and will be sending out a long-term play if the fundamental outlook instigates this technical set-up.