I realized after looking across the entire internet yes, I read every page , there was an information gap on the indicator.
See how you can learn to trade stocks, futures and bitcoin risk-free. Well, in this post I will provide you with six trading strategies you can test to see which works best for your trading style.
Please take a moment to browse the table of contents to help navigate this lengthy post. I created this post to help people learn six highly effective Bollinger Bands trading strategies they could start using immediately. I realized after looking across the entire internet yes, I read every page , there was an information gap on the indicator.
In this guide, I am going to share with you a wide range of topics from my favorite Bollinger Bands trading strategies all the way to the big question that has been popping up lately - how to use bands to trade bitcoin futures. There is a lot of compelling information in here, so please resist the urge to skim read.
I promise I will make this as painless as possible, but it would be wrong of me not to give my newbies the "who created and what are" Bollinger Bands introduction. Bollinger Bands are a powerful technical indicator created by John Bollinger. Some traders will swear trading a Bollinger Bands strategy is key to their success if you meet people like this be wary. There are no holy grails or free lunches in the business of trading.
The bands encapsulate the price movement of a stock. It provides relative boundaries of highs and lows. The crux of the Bollinger Band indicator is based on a moving average that defines the intermediate-term "trend" based on the time frame you are viewing. This trend indicator is known as the middle band. Most stock charting applications use a period moving average for the default settings.
The upper and lower bands are then a measure of volatility to the upside and downside. They are calculated as two standard deviations from the middle band. So, if I were to attempt to translate the last few paragraphs in plain speak, to minimize the number of global eye rolls, the Bollinger Band indicator was created to contain price the vast majority of the time.
Regardless of the trading platform, you will likely see a settings window like the following when configuring the indicator. If you are new to trading, you are going to lose money at some point. This process of losing money often leads to over-analysis. While technical analysis can identify things unseen on a ticker, it can also aid in our demise.
In the old times, there was little to analyze. Therefore, you could tweak your system to a degree, but not in the way we can continually tweak and refine our trading approach today.
Case in point, the settings of the bands. While the configuration is far simpler than many other indicators, it still provides you the ability to run extensive optimization tests to try and squeeze out the last bit of juice from the stock. The problem with this approach is after you change the length to My strong advice to you is not to tweak the settings at all. It's better to stick with 20, as this is the value most traders are using to make their decisions.
Now that we have covered the basics let's shift our focus over to the top 6 Bollinger Bands trading strategies. Before we jump into the strategies, look at the below infographic titled '15 Things to Know about Bollinger Bands'. The information contained in the graphic will help you better understand the more advanced techniques detailed later in this article. Well, the indicator can add that extra bit of firepower to your analysis by assessing the potential strength of these formations.
Let's unpack each strategy, so you can identify which one will work best with your trading style. The first bottom of this formation tends to have substantial volume and a sharp price pullback that closes outside of the lower Bollinger Band. These types of moves typically lead to what is called an "automatic rally.
After the rally commences, the price attempts to retest the most recent lows that have been set to challenge the vigor of the buying pressure that came in at that bottom. Many Bollinger Band technicians look for this retest bar to print inside the lower band. This indicates that the downward pressure in the stock has subsided and there is a shift from sellers to buyers. Below is an example of the double bottom outside of the lower band which generates an automatic rally.
In addition, the candlestick struggled to close outside of the bands. Another simple, yet effective trading method is fading stocks when they begin printing outside of the bands. Now, let's take that one step further and apply a little candlestick analysis to this strategy. For example, instead of shorting a stock as it gaps up through its upper band limit, wait to see how that stock performs.
If the stock gaps up and then closes near its low and is still entirely outside of the bands, this is often a good indicator that the stock will correct on the near-term. You can then take a short position with three target exit areas: As you can see from the chart, the candlestick looked terrible.
The single biggest mistake that many Bollinger Band novices make is that they sell the stock when the price touches the upper band or buy when it reaches the lower band. Bollinger himself stated a touch of the upper band or lower band does not constitute a buy or sell signal. Notice how the volume exploded on the breakout and the price began to trend outside of the bands; these can be hugely profitable setups if you give them room to fly.
I want to touch on the middle band again. Just as a reminder, the middle band is set as a period simple moving average in many charting applications.
The middle line can represent areas of support on pullbacks when the stock is riding the bands. You could even increase your position in the stock when the price pulls back to the middle line. Regarding identifying when the trend is losing steam, failure of the stock to continue to accelerate outside of the bands indicates a weakening in the strength of the stock. This would be a good time to think about scaling out of a position or getting out entirely.
Another trading strategy is to gauge the initiation of an upcoming squeeze. John created an indicator known as the band width. The idea, using daily charts, is that when the indicator reaches its lowest level in 6 months, you can expect the volatility to increase. This goes back to the tightening of the bands that I mentioned above. This squeezing action of the bollinger band indicator foreshadows a big move.
You can use additional signs such as volume expanding, or the accumulation distribution indicator turning up. We need to have an edge when trading a bollinger band squeeze because these setups can head-fake the best of us. It immediately reversed, and all the breakout traders were head faked.
You don't have to squeeze every penny out of a trade. Wait for some confirmation of the breakout and then go with it. If you are right, it will go much further in your direction. Notice how the price and volume broke when approaching the head fake highs yellow line. To the point of waiting for confirmation, let's look at how to use the power of a Bollinger Band squeeze to our advantage. Notice how leading up to the morning gap the bands were extremely tight.
Now some traders can take the elementary trading approach of shorting the stock on the open with the assumption that the amount of energy developed during the tightness of the bands will carry the stock much lower. Another approach is to wait for confirmation of this belief. So, the way to handle this sort of setup is to 1 wait for the candlestick to come back inside of the bands and 2 make sure there are a few inside bars that do not break the low of the first bar and 3 short on the break of the low of the first candlestick.
Based on reading these three requirements you can imagine this does not happen very often in the market, but when it does, it's something else. The below chart depicts this approach.
Now let's look at the same sort of setup but on the long side. Below is a snapshot of Google from April 26, Any breakout above or below the bands is a major event. The breakout is not a trading signal. The mistake most people make is believing that that price hitting or exceeding one of the bands is a signal to buy or sell. Breakouts provide no clue as to the direction and extent of future price movement. They are simply one indicator designed to provide traders with information regarding price volatility.
John Bollinger suggests using them with two or three other non-correlated indicators that provide more direct market signals. He believes it is crucial to use indicators based on different types of data. This strategy has become one of the most useful tools for spotlighting extreme short-term price moves. Learn to pounce on the opportunity that arises when other traders run and hide. Bollinger Bands have become an enormously popular market tool since the s but most traders fail to tap its true potential.
This intraday strategy picks tops and bottoms based on a clear recovery following an extreme move. If you were bullish, you had a natural tendency to draw the bands so they presented a bullish picture, if you were bearish the natural result was a picture with a bearish bias. This was clearly a problem. We tried reset rules like lookbacks with some success, but what we really needed was an adaptive mechanism. I was trading options at the time and had built some volatility models in an early spreadsheet program called SuperCalc.
One day I copied a volatility formula down a column of data and noticed that volatility was changing over time.
Seeing that, I wondered if volatility couldn't be used to set the width of trading bands. That idea may seem obvious now, but at the time it was a leap of faith. At that time volatility was thought to be a static quantity, a property of a security, and that if it changed at all, it did so only in a very long-term sense, over the life of a company for example.
Today we know the volatility is a dynamic quantity, indeed very dynamic. After some experimentation I settled on the formulation we know today, an n period moving average with bands drawn above and below at intervals determined by a multiple of standard deviation We use the population calculation for standard deviation. The defaults today are the same as they were 35 years ago, 20 periods for the moving average with the bands set at plus and minus two standard deviations of the same data used for the average.
I had presented a chart showing an unconfirmed tag of my upper band and explained that the first down day would generate a sell signal. Bill then asked me what I called those lines around the price structure, a question that I was totally unprepared for, so I blurted out the alliteratively obvious choice: They are curves drawn in and around the price structure usually consisting of a moving average the middle band , an upper band, and a lower band that answer the question as to whether prices are high or low on a relative basis.
Bollinger Bands work best when the middle band is chosen to reflect the intermediate-term trend, so that trend information is combined with relative price level data.
For many years that was the state of the art: Here are a couple of practical examples of the usage of Bollinger Bands and the classic Bollinger Band tools along with a volume indicator, Intraday Intensity:. Click chart to enlarge.