By Dave Floyd and Bo Harvey of the Aspen Trading Group

One very different aspect of Forex trading is that there is no volume to offer clues as to when this momentum has sufficient fuel -- there is only price. For example, in a stock, if a price consolidates just below a key level on lower-than-average volume, then breaks through on strongly increasing volume, it gives the trader added confidence in the breakout because it reveals that the bigger market players are tipping their hand in the form of volume. "Volume precedes price," as they say.

In Forex, however, there is no such added level of analysis. There is only price, nothing more. In this sense, Forex is very conducive to technical analysis, especially a focus on price action alone. However, stock traders who may be used to relying on volume to garner clues as to the health of a breakout / breakdown will have to shift their perspective because price itself becomes the sole indicator. In this respect, it is very important in Forex trading to wait for price to confirm a move out of a non-directional range.

How can this be done? One of the more straightforward ways we have relied on is using Bollinger Bands. Bands can help determine when price is ready to trend versus consolidate, essentially helping to answer the question: When is this thing ready to make a move?

All markets alternate between non-directional and directional phases, and distinguishing between the two is critical in Forex trading. Non-trending currencies can really chop a trader to death while trending pairs can offer great opportunities for profits. Being able to navigate between the two (without using volume as a confirming / diverging indicator as stock traders sometimes do) can considerably affect trading results. Take a look at the 60-minute chart of the Pound:

You can see a very clear thrust, consolidation, thrust pattern in GBP from December 16 to December 18: Very fertile trading ground. Study the Bollinger Bands and notice how the “mouth” of the band begins to widen as price moves out of consolidation; then, price “rides” the upper band higher.

After a “ride,” price begins to fall away from the band as it enters a non-directional phase. The Bands then begin to contract swiftly, tightening up as price consolidates. Then, the pattern repeats itself. Knowing when price is in a trending mode versus a non-directional “chop” mode helps the trader pinpoint more precise entries and exits and, just as importantly, identify times when it is prudent to stay out.

Here is another example, from a daily NZD / USD chart. Notice how, in late December, the Kiwi was in a very tight sideways range, with the Bollinger Bands reflecting severely constricted price. This preceded an explosive move higher once NZD broke higher out of the range, identified by a rapidly widening Band. Noting the tight range that came before can also help give added confirmation that the pendulum was shifting back to a strong trend after being in a very narrow range:

In this way, Bollinger Bands help one navigate around these alternating consolidation / thrust phases in currencies, especially for stock traders who may be used to relying on short-term volume indicators.
If you are new to Forex, study the way Bollinger Bands contract and expand in a trending currency and use them to identify when a currency is beginning to resume its trend and when it may be falling back into consolidation. This will help the you pinpoint swing entries and exits more precisely, just as stock traders use volume to pinpoint when there is sufficient buying or selling “fuel” to drive a stock sharply higher or lower.
In coming articles, we will expand into other areas of Forex, both from a technical and fundamental standpoint.

*Reprinted (and modified) with permission from the Aspen Trading Group