Bollinger Bands Trading Strategies

Bollinger Bands Trading Strategies: Backtest And Performance

Unlock the full potential of your trading with Bollinger Bands trading strategies that are straightforward and powerful. This guide demystifies how to use Bollinger Bands for robust market entry and exit frames, exploiting periods of market calm and volatility alike. Expect a no-nonsense breakdown of the best practices and prudent applications, tailored to secure your trades no matter the market’s mood. Get ready to enhance your approach with sharp, strategic insights using Bollinger Bands trading strategies.

We conclude that Bollinger Bands are somewhat profitable in the stock market, which is a market that is very mean-revertive. We tested some ideas for Bollinger Band trading strategies, and it seem to work as a breakout indicator in gold. However, we didn’t manage to find any useful Bollinger Bands strategies for stock indices.

Table of contents:

Key Takeaways

  • Bollinger Bands are a versatile tool in technical analysis to assess market volatility and potential price movements, with strategies based on the bands’ contractions (squeezes), expansions, or where the price lies in relation to the bands.
  • Traders should not rely solely on Bollinger Bands; they should use multiple indicators and confirmation methods to increase trade accuracy and manage risks, such as implementing stop-loss orders and adjusting settings based on the timeframe.
  • Despite their wide application, Bollinger Bands have limitations, including potential delayed signals and the risk of misinterpretation, especially during strong trending markets without a corresponding trend reversal.
Bollinger Bands - Volatility Insights, Trading Strategies
Bollinger Bands Trading Strategies

1. Bollinger Band Squeeze

In the world of trading strategies, the Bollinger Band Squeeze strategy is a true standout. It identifies periods of low volatility—when the price of a security is consolidating and the upper and lower Bollinger Bands are moving closer together. This phenomenon is known as a “squeeze”.

Traders using this strategy anticipate that after this period of consolidation, the price will make a larger move in either direction, often on high volume. When the price breaks through the upper or lower band during a squeeze, it can indicate a potential breakout, prompting the trader to buy or sell the asset, respectively. However, it’s important to note that a “head fake” can occur, where the stock appears to break out in one direction only to reverse and move significantly in the opposite direction. This highlights the importance of confirmation and risk management in trading.

Bollinger Band Squeeze strategy

2. Bollinger Band Breakouts

The Bollinger Bands strategy, known as the Bollinger Band Breakouts, takes advantage of price changes signaled by the bands. This Bollinger Bands trading strategy, often used in bollinger bands trading, is employed to identify potential trading opportunities when the price breaks through the bands, signaling a change in market volatility. The default settings for Bollinger Bands include a 20-day moving average and 2 standard deviation lines.

A price break above the upper Bollinger Band is considered a bullish signal, prompting traders to consider entering a long position. Conversely, a break below the lower Bollinger Band is seen as a bearish signal, suggesting traders might enter a short position. However, it’s important to remember that the Bollinger Band Breakouts strategy should be used in conjunction with other market analysis and technical indicators to increase its effectiveness.

Bollinger Band Breakouts

3. Bollinger Band %B

The Bollinger Band %B is another valuable tool in a trader’s arsenal. It quantifies a security’s price relative to the upper and lower Bollinger Bands, helping traders identify overbought or oversold conditions. The %B indicator is calculated using a specific formula, which essentially measures the price’s position within the range defined by the bands.

The %B indicator identifies six basic relationship levels.

  • Below 0 (price is below the lower band)
  • 0 (price at the lower band)
  • Between 0 and 0.50 (price between the lower and middle band)
  • Between 0.50 and 1 (price between the middle and upper band)
  • 1 (price at the upper band)
  • Above 1 (price above the upper band)

By providing valuable insights into price positioning, %B is an effective tool for identifying potential trading opportunities. Here is an example with a strategy built upon it. Larry Connors’ %b Strategy

4. Bollinger Band Walks

Bollinger Band Walks strategy is designed to help traders navigate strong trends. In this strategy, the price moves along the upper or lower band during a strong trend, offering multiple entry and exit points. During an uptrend, traders may consider opening long positions when the price rebounds from the upper band. They might then choose to exit these positions should the price fall below the middle band.

In a downtrend, the strategy involves entering short positions when the price rebounds from the lower band. It also suggests exiting the position when the price moves above the middle band. This strategy uses related indicators to Bollinger Bands, such as Bollinger %B, to measure the price’s relative position, helping identify overbought or oversold conditions and potential reversals.

5. Basic Bollinger Bounce

The Basic Bollinger Bounce strategy is another popular approach among traders. One strategy is to buy when the price drops below the lower Bollinger Band and to sell when it exceeds the upper Bollinger Band. This approach relies on the band’s fluctuations to inform trading decisions. This strategy is often used in conjunction with the Relative Strength Index (RSI) to confirm and trade the “bounce” off the upper or lower band.

The use of Bollinger Bands in the Bounce strategy offers traders a clear visual representation of potential buy and sell zones. However, it’s important to note that the Bollinger Bands should be used in conjunction with other indicators like the Moving Average Convergence Divergence (MACD) or the Stochastic Oscillator to filter out false signals and provide more reliable trading signals.

Bollinger Band Walks strategy

6. Double Bollinger Band Trend-Following

The Double Bollinger Band Trend-Following strategy adds another layer to the traditional use of Bollinger Bands. It involves using two sets of Bollinger Bands, one set with a standard deviation of one (1 SD) and another set with a standard deviation of two (2 SD), to identify the prevailing trend.

In an uptrend, the price tends to stay between the upper Bollinger Bands +1 SD and +2 SD away from the mean, indicating a “buy zone”. Conversely, a downtrend is indicated when the price is between the lower two Bollinger Bands, known as the ‘sell zone’.

The Double Bollinger Band strategy should be used with additional technical analysis tools for more robust trade confirmation.

Basic Bollinger Bounce strategy

7. Bollinger Band Width Strategy

The Bollinger Band Width Strategy zeroes in on the spacing between the upper and lower bands. It utilizes this space as a metric to assess whether the trend is gaining or losing strength by monitoring how far apart these bands are—the width reflects market volatility.

When it comes to interpreting Bandwidth, context matters. What is seen as “narrow” should be assessed relative to past measures of this distance over an adequate period for that specific asset. This approach offers traders an additional analytical tool that can enhance their trading strategy when used alongside other technical analysis methods and indicators.

8. Bollinger Bands with RSI Divergence

The Bollinger Bands with RSI Divergence approach combines the use of the Relative Strength Index (RSI) and Bollinger Bands to pinpoint potential extremes in market conditions. This method seeks out occurrences where the RSI traverses beyond the upper or lower Bollinger Band, signifying possible overbought or oversold scenarios.

When observing an instance where the RSI crosses above the upper limit of its respective Bollinger Band, this might be a precursor to an imminent price correction or reversal due to a perceived overbought state. Conversely, should there be a dip in RSI below the threshold of the lower belliger bands, it is often considered as signaling oversold circumstances that could lead up to a rally in prices. Yet it’s crucial to incorporate additional indicators alongside price action analysis when utilizing this strategy for trade decisions. Doing so ensures more robust validation before moving forward with any transaction.

Double Bollinger Band Trend-Following strategy

9. Bollinger Bands Pinch Play

The Bollinger Bands Pinch Play strategy is another tool that traders can use to identify potential breakouts. The strategy involves identifying periods where the price has been moving aggressively and then starts to move sideways in a tight consolidation. This is often seen when the upper and lower Bollinger Bands get closer together, indicating decreased volatility.

After a consolidation period, the price often makes a larger move in either direction, which is an ideal situation for a breakout strategy. Traders using the Pinch Play strategy look for securities with narrowing Bollinger Bands and low BandWidth levels, with BandWidth ideally near the low end of its six-month range.

It is also important to be wary of the “head fake,” where prices break a band only to quickly reverse direction, which can be likened to a bull or bear trap.

10. Bollinger Bands Reversal

The Bollinger Bands Reversal strategy uses the bands to identify potential price reversals and generate buy or sell signals. Traders use this strategy by monitoring when the price touches or breaches the upper or lower bands, which may indicate overbought or oversold conditions, respectively.

When using Bollinger Bands, keep the following in mind:

  • When the price reaches the upper band, it suggests an overbought condition and a potential reversal to the downside.
  • If the price moves back inside the bands after breaching the lower or upper band, it can be a signal for a potential reversal back towards the middle band.
  • However, traders should exercise caution when the bands are contracting, as it might indicate low volatility and the potential for a breakout, rather than a reliable bounce.

11. Bollinger Bands Volatility Contraction

The Bollinger Bands Volatility Contraction strategy is a method that focuses on periods of low volatility, anticipating potential price breakouts. The strategy identifies periods where the price of a security is consolidating and the upper and lower Bollinger Bands are converging, indicating decreased volatility.

After a consolidation period, the price often makes a larger move in either direction, offering an ideal situation for a breakout strategy, which is a popular trading style.

The Bollinger Bands Volatility Contraction strategy is effective during market conditions where the asset price is consolidating and the upper and lower bands are converging, indicating decreased volatility.

12. Bollinger Bands Triple Strategy

The Bollinger Bands Triple Strategy adds another dimension to the traditional use of Bollinger Bands. It involves using three different Bollinger Band settings to identify trend strength, reversals, and potential entry points. This strategy involves adding a Bollinger Band indicator to the chart, identifying the preceding trend, isolating a double top or bottom, and examining the peaks’ interaction with the Bollinger Bands.

In this strategy, the triple Bollinger Band setup includes:

  • Using a simple moving average (SMA) as a reference point, where price crossing the SMA(200) might indicate a strong trend and a signal to avoid trading against it.
  • Different Bollinger Band deviations (e.g., 1, 2, 3) are used to create levels of support and resistance.
  • The price typically bounces back when touching these lines.

What Are Bollinger Bands?

Bollinger bands are a technical analysis tool that measures price volatility. They consist of a simple moving average (SMA), referred to as the middle band, and two standard deviation-based bands above and below the SMA. The tool was developed by John Bollinger to help traders identify when an asset is potentially oversold or overbought.

The bands are typically set at 2 standard deviations above and below a 20-day SMA, though these settings can be adjusted. When the market price continually touches the upper Bollinger Band, it may suggest an overbought condition, and touching the lower band may indicate an oversold condition. Thus, you have three bands:

Bollinger band strategy
An example of a 20-day Bollinger Band on the S&P 500.

The above chart shows the 20-day simple moving average (the blue line), and the red lines above and below are added and subtracted 2 standard deviations from the moving average. In times of high volatility, the bands expand. In times of low volatility, the bands contract. Why do they expand and contract? This is because the bands react to the volatility of the share price – the standard deviation:

How do Bollinger Bands work?

As mentioned above, the middle line, the moving average, forms the basis of the indicator. As the price moves along, the upper and lower bands are adjusted to reflect the price’s past variations. This, of course, means that the indicator only looks back and basically reacts to the past x days’ volatility.

Nassim Nicholas Taleb has been a strong advocate of the randomness of the markets. The fact is that the variability of the markets is not like the bell curve. Anyone who has traded should be familiar with expressions like “fat-tails” and “tail risk“.

Fat tails reflect that big moves happen more often than the statistics suggest. As an example, look at what happened to the Swiss Franc in January 2015. The Swiss National Bank removed the cap on the CHF resulting in a gigantic appreciation of the currency. This, of course, resulted in huge losses (and gains for others). The point is, no model can ever predict such moves, and certainly not Bollinger Bands.

How Bollinger Bands Work

What are some critical Components of Bollinger Bands?

Bollinger Bands are composed of a few essential elements with which traders should be familiar. At the heart lies the middle band, represented by a simple moving average (SMA). Flanking this on either side are the upper and lower bands, positioned at a specified number of standard deviations from this central SMA.

Typically, for Bollinger Bands configuration, two standard deviations above and below the 20-day simple moving average define where to place the upper and lower bands respectively. The use of standard deviation as part of this technical tool establishes how far both upper and lower bands will sit in relation to that middle SMA.

What Bollinger Bands Settings can you adjust?

Traders can adjust the period of the moving average within the Bollinger Bands, making the moving average smoother with a longer period or more sensitive with a shorter period. The standard deviation settings of Bollinger Bands can be modified, with the default setting being 2 standard deviations, but traders may use settings such as 1 or 2.5 to make the bands more or less responsive to market volatility.

For scalping strategies, the recommended Bollinger Bands settings are a 9-period moving average with 2 standard deviations. Traders can also adjust the type of moving average used in Bollinger Bands, choosing between a simple moving average (SMA) or other types like an exponential moving average (EMA), depending on their preference for sensitivity to price changes.

Explain Bollinger Bands’ upper and lower bands.

The upper and lower bands of Bollinger Bands are significant components of this trading tool. These bands are set a certain number of standard deviations away from the middle band, which is a moving average of the price. The upper band can act as a resistance level in an uptrend, where prices may be considered overbought if they touch or exceed the upper band.

Conversely, the lower band can serve as a support level in a downtrend, where prices may be considered oversold if they touch or fall below the lower band. The calculation of Bollinger Bands involves adding and subtracting a standard deviation calculation from the moving average, which creates the upper and lower bands, helping traders identify periods of high and low price volatility.

What are the different adjustments for Lookback Periods and Standard Deviations?

In Bollinger Bands, modifying the moving average lookback period changes its responsiveness to price movements. Increasing this period results in a larger number of past prices included in the calculation, which typically yields less frequent but potentially stronger signals because it dampens the impact of short-term volatility. A shorter lookback period incorporates fewer historical prices and thus responds more quickly to recent shifts in price, providing a greater quantity of trading signals that may contain a higher rate of false positives.

Adjustments can also be made to how many standard deviations are used to set the upper and lower bands within Bollinger Bands. Expanding these limits by using more standard deviations creates broader bands. Contracting them with fewer standard deviations leads to tighter bands. With wider space between upper and lower thresholds due to an increase in standard deviations, there’s often a reduction in trading signal frequency since prices need larger swings for contact with either band boundary.

What does it indicate when Bollinger Bands widen?

An increase in volatility is indicated by the expansion of Bollinger Bands, which can be a harbinger for the initiation of a pronounced trend movement. This widening effect often comes after a phase of market consolidation or squeeze, hinting at a shift from lower to higher volatility conditions.

When there’s substantial separation between the Bollinger Bands, it frequently accompanies the formation of an intense trend and typically succeeds what’s termed as “the squeeze.” The squeeze represents an interval with diminished volatility and could portend emerging trading prospects stemming from anticipated surges in market volatility.

What does the contraction of Bollinger Bands signify?

A narrowing of Bollinger Bands suggests a decline in market volatility and the possibility of impending consolidation. This phenomenon, referred to as the squeeze, is characterized by a period during which stock volatility hits a six-month nadir.

Such restricted conditions within the Bollinger Bands typically act as precursors for forthcoming market breakouts. It’s common for stocks to transition from phases exhibiting minimal volatility into ones marked by significant price swings following these contractions.

Can you measure volatility with Bollinger Bands?

Certainly, Bollinger Bands function as an indicator of market volatility by examining the distance between the upper and lower bands. When these bands are close together, it signals a period of low volatility. Conversely, greater distances between them denote increased market volatility. These bands are typically configured with a 20-period moving average at their core while positioning the upper and lower bands two standard deviations from this central average to accurately reflect changes in market conditions.

According to the principles behind Bollinger Bands, there is often a cyclical nature to volatility. It’s common for times characterized by tight band convergence—or ‘squeeze’—to be succeeded by periods displaying expanded levels of fluctuation or higher volatility, and so on. The dynamic design of these bands means they automatically adjust to shifts in asset price movements. They expand in response to heightened fluctuations (increased volatility) and contract when such fluctuations diminish (decreased volatility).

Where do prices tend to stay in relation to the Bollinger Bands during an uptrend?

In a bullish market trend, it’s common to observe the prices oscillating between the 20-day moving average and the upper Bollinger Band. The proximity of prices to the upper band in this scenario suggests that it serves as an anticipated price ceiling.

Consistent contact with the upper Bollinger Band during periods of rising prices may signal an overbought market environment indicative of a strong uptrend. If, within such an uptrend, there is a retreat in prices but they stay above the middle band before ascending back towards the upper band, this behavior typically reflects substantial momentum behind the prevailing trend.

In relation to the Bollinger Bands, where do prices remain during a downtrend?

During a downtrend, it is common for prices to linger below the central Bollinger Band. They may trace along the lower Bollinger Band, presenting numerous opportunities for traders to take and close short positions.

In instances of a pronounced downtrend, prices tend to hug the lower band of the Bollinger Bands consistently – a sign that there’s sustained pressure from sellers. If during such a downward trend prices do not approach or track with this lower band, this could be an indication that the strength of the downward movement is waning.

What does it indicate when prices reach or breach the upper Bollinger Band?

The continual contact of prices with the upper Bollinger Band is seen as a signal that the market might be in an overbought state, indicating a potential extension too far on the upside. The approach of asset prices toward the upper Bollinger Band could suggest that, relative to recent price action, the asset may be considered overbought, prompting traders to consider taking sell positions or anticipate a retraction in the market.

Should there be a breakout above the upper band amidst an existing trend, it could imply that there’s momentum sufficient enough for continuation of said trend. Thus offering opportunities for trend traders. Consistent touching or surpassing of this same upper band often leads observers to conclude that securities have reached excessive heights and might soon experience some form of correction.

How can traders potentially profit from using Bollinger Bands to spot reversals?

Traders can potentially profit from using Bollinger Bands to spot reversals by identifying when prices have reached or breached the upper or lower bands. To identify a Bollinger Band reversal pattern, traders should look for a double top or double bottom that interacts with the Bollinger Bands, indicating a potential reversal of the preceding trend.

The traditional entry point for a Bollinger Band reversal is using the neckline of the double top or bottom as a reference point, where a break triggers the entry. Stops for the reversal trade are typically set at recent swing highs or lows, while take profit levels can be determined by price action or Fibonacci levels.

What might a reversal to the downside indicate when prices reach the upper Bollinger Band?

If prices approach the upper Bollinger Band and then exhibit a downward reversal, it could be viewed as a potential sell signal. Consistent contact with the upper band can indicate that the stock is overvalued or in an overbought condition, signifying that it might be trading above its true value.

Should there be a subsequent dip below the 20-day moving average— which serves as the middle line of Bollinger Bands— after touching the upper bollinger band, this movement may serve as an alert for an upcoming downtrend. Traders often interpret such a downturn following proximity to the upper bollinger band as a cue to consider selling since it suggests weakening bullish momentum and forewarns of possible decline in price trajectory.

What does it indicate when the price touches or moves above the upper Bollinger Band?

When the price reaches or surpasses the upper Bollinger Band, it may indicate that conditions are overbought and present potential opportunities for selling. It is viewed as a signal of being overbought when the price consistently makes contact with the upper Bollinger Band, implying that there might be an excessive bullish push in the market.

For trend traders who follow strategies designed to benefit from momentum shifts and signs of trend fatigue, a rise above the upper Bollinger Band could prompt considerations for sell trades. Traders looking to capitalize on early indications of diminishing trend strength—known as fade traders—may see prices touching or moving past this band as an opportunity to begin taking short positions.

What might it suggest when the price touches or falls below the lower Bollinger Band?

Touching or falling below the lower Bollinger Band may indicate oversold conditions and potential buy opportunities. When the price touches the lower Bollinger Band, it is often considered a potential buying opportunity, indicating that the price is near the lower limit of its recent volatility range and might reverse direction and move upward.

The touch of the lower Bollinger Band can suggest:

  • The asset is oversold, which may present a potential buy signal for traders expecting a price bounce back.
  • If the price consistently touches or moves beyond the lower band, it may signal a strong downtrend.
  • A bounce from the lower band can indicate a possible reversal upward.

What is the Bollinger Band Squeeze strategy primarily used to anticipate?

The Bollinger Band Squeeze strategy is primarily used to anticipate price breakouts during periods of low market volatility. The strategy is based on the observation that periods of low volatility, indicated by the Bollinger Bands contracting or coming together, often precede significant price movements or breakouts.

A Bollinger Band Squeeze is identified when the distance between the upper and lower bands decreases, signaling decreased volatility and potential upcoming market movement in either direction. The Bollinger Band Squeeze strategy does not always result in profitable trades, as it can be influenced by whipsaws and may require additional technical analysis tools for improved effectiveness.

During what market condition is the Bollinger Band Squeeze strategy most effective?

During periods of consolidating or range-bound market conditions, the Bollinger Band Squeeze strategy becomes highly effective. It’s particularly potent after a phase of low volatility when the market appears to be in a state of consolidation.

When there is a convergence between the upper and lower bands, this indicates a decrease in volatility and suggests that the asset price is consolidating—a prime setting for employing this strategy. The anticipation with the Bollinger Band Squeeze is that subsequent breakouts will determine the directionality of price action over ensuing days or weeks.

What does a price break through the upper or lower Bollinger Bands indicate in the Bollinger Band Breakout strategy?

When utilizing the Bollinger Band Breakout strategy, a price movement through either the upper or lower Bollinger Bands signals potential for an ongoing trend and presents trading opportunities. Should the price penetrate the upper bollinger band, it could imply that the market is reaching overbought conditions, potentially leading to a retraction in prices. On the flipside, if an asset’s price drops below the lower bollinger band, this may be indicative of overly depressed prices with room for a rebound.

During a prevailing trend, a break above the upper band may signal continued momentum in that direction, offering traders opportunities to capitalize on such movements. Entry positions might be taken upon witnessing a breakout through Bolliger bands by traders who also factor in overall market trajectory ensuring their actions are congruent with existing trends.

How can traders adjust Bollinger Bands for different timeframes?

Traders can adjust Bollinger Bands for different timeframes by changing the SMA length. The standard deviation settings can also be modified to make the bands more or less responsive to market volatility. For scalping strategies, the recommended Bollinger Bands settings are a 9-period moving average with 2 standard deviations.

Traders can customize Bollinger Bands by adjusting the following parameters:

  • Type of moving average used: simple moving average (SMA) or exponential moving average (EMA)
  • Lookback period for calculating the moving average and standard deviations
  • Multiples of the standard deviation from the moving average used to set the upper and lower bands

These customization options offer flexibility in determining the bandwidth of Bollinger Bands.

What is the default period for the Simple Moving Average (SMA) used in Bollinger Bands?

The Bollinger Bands typically employ a 20-period Simple Moving Average (SMA) to establish the middle band. This particular period length is selected as it effectively reflects the intermediate trend, striking an ideal balance for its purpose.

This central element of Bollinger Bands acts as the foundation from which both upper and lower bands are derived by applying a specified number of standard deviations away from this average line. These adaptable boundaries contract when market volatility decreases and widen in response to heightened market activity, thus dynamically adjusting to varying trading conditions.

How do shorter timeframes affect the signals generated by Bollinger Bands?

Shorter timeframes result in Bollinger Bands being more sensitive to price movements, leading to a higher number of trading signals. The increased number of signals on shorter timeframes can result in more false positives, where the price might appear to breakout or reverse but does not follow through.

On shorter timeframes, Bollinger Bands might produce signals that are more reflective of market noise rather than significant price moves. Traders using shorter timeframes with Bollinger Bands need to be cautious of overreacting to every band touch or breach, as these could be minor fluctuations rather than trend changes.

bollinger-bands

How do longer timeframes impact the reliability of signals produced by Bollinger Bands?

Longer timeframes provide more reliable signals when using Bollinger Bands because they reduce the noise and false moves seen in shorter timeframes. Traders often use a longer timeframe to define the primary trend and ensure that their strategy is aligned with the overall market direction, which enhances the reliability of Bollinger Bands signals.

By focusing on a longer timeframe, traders can avoid the over-analysis and confusion that can arise from the noise on short-term charts, leading to more reliable Bollinger Band signals. The wider bands on longer timeframe charts reflect greater market moves, offering clearer insights into the potential strength or weakness of the current trend.

How do traders use Bollinger Bands for entry points?

Traders use Bollinger Bands for entry points by monitoring the position of the price relative to the bands and confirming with other indicators before setting entry and exit points. Traders manage risk by placing stop-loss orders just below or above the breakout point when using Bollinger Band Breakouts strategy.

Bollinger Bands can be used in conjunction with other technical indicators like RSI, MACD, and Stochastic Oscillator to confirm trading signals and reduce false signals. Traders adapt Bollinger Bands to different timeframes to suit their trading needs, with shorter timeframes potentially requiring a smaller SMA length and longer timeframes a larger SMA length.

Do Bollinger Bands work?

It’s impossible to have a definite answer because you can use the bands in a wide range of possibilities. Moreover, some asset classes show different patterns and characteristics than others, and thus one way of using the Bollinger Bands doesn’t fit all markets.

Can Bollinger Bands indicate market volatility?

By gauging the gap between the upper and lower bands, Bollinger Bands serve as a tool for identifying market volatility. These bands widen when market volatility is high, indicating active trading periods. Conversely, they narrow during times of low volatility to signal quieter market conditions.

According to the principle behind Bollinger Bands, there is a tendency for volatility to revert back to its average. This suggests that when traders observe a narrowing of these bands—referred to as a ‘squeeze’—it could be an indication that higher levels of price fluctuations are on the horizon after this period of calm. The unique feature of these bands is their ability to automatically adjust their width in response to changing asset price volatility: expanding with increases and contracting with decreases in such activity.

What are the limitations of Bollinger Bands?

Bollinger bands are a powerful tool, but they do have some limitations. These limitations should be considered when using them for analysis. They should not be used as a standalone tool and are most effective when used with other non-correlated indicators. Bollinger Bands are calculated using a simple moving average, which means that older price data is weighted equally with recent data, potentially skewing the analysis.

Bollinger Bands are prone to providing delayed signals which can lead to missed opportunities or false indications of trend changes. The bands can also incorrectly signal an overbought or oversold condition if prices continually touch the upper or lower bands without a corresponding reversal in trend. Traders should be cautious of interpreting the touch of the outer Bollinger Bands during strong trends as a reversal signal, when it could simply indicate a pause or retracement, leading to premature or incorrect trading decisions.

Who created Bollinger Bands?

Bollinger Bands were created by John Bollinger in the 1980s. John Bollinger is a well-known technical analyst who developed this tool to measure market volatility and identify overbought or oversold conditions in the trading of financial instruments. Bollinger Bands consist of a middle band being a moving average, usually a simple moving average (SMA), with two outer bands that are plotted two standard deviations away from the middle band. The spacing between the bands varies based on the volatility of the prices.

How do traders manage risk with Bollinger Bands?

Traders manage risk with Bollinger Bands by setting stop-loss orders, using additional indicators for confirmation, and implementing proper risk management techniques. By placing stop-loss orders just below or above the breakout point when using Bollinger Band Breakouts strategy, traders can limit potential losses.

Bollinger Bands can be used in conjunction with other technical indicators like RSI, MACD, and Stochastic Oscillator to confirm trading signals and reduce false signals. Traders adapt Bollinger Bands to different timeframes to suit their trading needs, with shorter timeframes potentially requiring a smaller SMA length and longer timeframes a larger SMA length.

Proper risk management practices include using position sizing and diversification when trading with Bollinger Bands.

Can you show an example of Bollinger Bands being overbought and oversold?

The most used method is probably to use the bands as overbought or oversold indications:

When the price closes outside the lower band, it indicates an oversold condition and vice versa.

Let’s test a simple strategy: When the share price closes two standard deviations below the 10-day average, go long. Exit when it crosses above the 10-day average.

On the S&P 500 we get this equity curve:

Bollinger band strategy example

As we can see, the performance has been reasonably well, but it failed to beat the “buy and hold” since 1993 by a wide margin. Since 2018 it has been a losing strategy.

How does a Bollinger Bands strategy with a trend filter look like?

Some traders use the Bollinger Bands as trend filters: when the price closes above the upper band, they go long. This doesn’t work on stocks, which is very mean-revertive, but it shows some promise on some commodities.

Let’s test to go long the gold price (GLD) if the close is above one standard deviation from the 10-day moving average.

Bollinger band backtest

You can also code the strategy to only go long after periods with very low volatility, ie. when the bands typically narrow.

On websites we see many recommend using Bollinger Bands as a trend filter. For example, when the price breaks above the upper bands, it might indicate a positive trend has started, and a position can be initiated when the price pulls back into the channel again. We have tried to write code for such a strategy, but we have found nothing to work.

Can you show me an example of a Bollinger Bands breakout strategy?

We were playing with ideas and numbers when we tested this simple idea: What happens when it breaks out of a short-term Bollinger Band channel, but the short-term bands are smaller than the long-term bands?

The general idea is only to trade breakouts when the bands are more narrow than “normal” (measured by the 100-day bands). This doesn’t work in stocks, but shows some promise in gold (GLD):

Bollinger band trading rules

Interestingly, this performs really bad in GDX (gold miners):

Bollinger bands settings

What is the best setting for Bollinger Bands?

As with any strategy, there is no best setting for any indicator, and not Bollinger Bands either. You have to play around with the indicator and perhaps you find something that might work.

What time frame is best for Bollinger Bands?

The best time frame for Bollinger Bands depends on your investment horizon. But the best time frame is, of course, the profitable one. If you’re a trader or investor, you want to invest your capital in profitable strategies. You need to be an investment agnostic and go after the profitable strategies. This means you can use different time frames depending on the asset class. What works in stocks doesn’t necessarily work in commodities.

Which indicator works best with Bollinger Bands?

There is no definite answer. Mean reversion works on stocks, at least for now, while mean reversion doesn’t work well in commodities. No strategy fits all markets. You have to play with indicators yourself.

What is %b (percent b)?

Larry Connors has twisted the Bollinger Band somewhat in chapter 5 of his book High Probability ETF Trading. Connors’ %b is a measurement that I believe he invented, but it’s just a small deviation from the Bollinger Bands. The calculation of %b is this in Amibroker:

percentB=( ( Close – BBandBot(C,10,2) ) / ( BBandTop(C,10,2) – BBandBot(C,10,2) ) )* 100;

Are Bollinger Bands profitable?

Yes, the Bollinger bands are profitable if used correctly. The Bollinger Bands are like all other indicators: it measures the past movement. Your task as a quantitative trader is to calculate how the past movement predicts future movement. As such, the Bollinger Bands shows some promise. However, we have

Summary

Bollinger bands are a versatile tool in the world of trading, providing valuable insights into market volatility and potential trading opportunities. By measuring the distance between the upper and lower bands, Bollinger Bands can help traders identify periods of low and high volatility, overbought and oversold conditions, and potential entry and exit points. With various strategies like the Bollinger Band Squeeze, Bollinger Band Breakouts, and Bollinger Band %B, traders can customize the tool to suit their trading style and needs. While Bollinger Bands can be a powerful tool, it’s important to use them in conjunction with other indicators and techniques to manage risk effectively and increase the probability of successful trades.

Frequently Asked Questions

Is Bollinger Band strategy profitable?

Yes, Bollinger Bands can be somewhat profitable in the stock market due to their effectiveness as a breakout indicator, especially in gold. It is a market that is very mean-revertive.

How do you use Bollinger Bands effectively?

When leveraging Bollinger Bands for trading decisions, consider initiating a purchase as the price surges past the upper band and think about selling when it dips below the lower band. Such movements may signal shifts in market volatility, presenting chances to commence or conclude transactions.

What is the best Bollinger Band strategy?

A top-performing strategy utilizing the Bollinger Band involves initiating purchases when the price action breaches the lower band, which typically signifies an oversold condition resulting from intense selling pressure. Employing methods such as the Bollinger Squeeze, incorporating indicators like RSI and MACD, focusing on reversals, trading within the bands, leveraging moving averages, and observing price action tactics are all considered effective approaches.

What are Bollinger Bands used for in trading?

In trading, Bollinger Bands serve to gauge market volatility and assist in spotting potential opportunities for trades by pinpointing times of high and low volatility as well as overbought and oversold conditions, which can signal optimal moments for entering or exiting the market.

What does it mean when Bollinger Bands widen?

The expansion of Bollinger Bands signifies a rise in market volatility and may signal the beginning of an important trend shift, providing a valuable cue for executing trade strategies.

Glossary – Bollinger Band Indicator

There are many terms and phrases used to describe the Bollinger Band indicator. Below we have summarized the most important in a glossary:

  1. Bollinger Bands: A technical analysis tool that consists of a middle band being a moving average, flanked by two standard deviation-based bands above and below it.
  2. John Bollinger: The financial analyst and trader who developed Bollinger Bands in the 1980s.
  3. Moving Average (MA): A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random short-term price fluctuations.
  4. Simple Moving Average (SMA): A type of moving average that is calculated by adding the recent closing prices of an asset and dividing the total by the number of time periods in the calculation average.
  5. Exponential Moving Average (EMA): A type of moving average that gives more weight to the most recent prices, making it more responsive to new information.
  6. Standard Deviation: A statistical measure of market volatility. It quantifies how much a series of numbers (e.g., prices) diverges from the average.
  7. Upper Band: The band above the moving average, typically set to two standard deviations above the MA.
  8. Lower Band: The band below the moving average, typically set to two standard deviations below the MA.
  9. Bandwidth: The width of the Bollinger Bands. It increases during periods of higher volatility and decreases in lower volatility environments.
  10. Volatility: A statistical measure of the dispersion of returns for a given security or market index.
  11. Breakout: A term used when the price of an asset moves outside a defined support or resistance level with increased volume.
  12. Squeeze: A market condition where the Bollinger Bands come very close together, indicating low volatility, often considered a precursor to a sharp price movement.
  13. Bollinger Bounce: A strategy that relies on the price bouncing off the lower or upper Bollinger Bands.
  14. Bollinger Squeeze: A strategy that involves trading breakouts after a squeeze.
  15. Price Channels: Lines that chart the highs and lows of an asset’s price over a certain period. Bollinger Bands can act as dynamic price channels.
  16. Resistance Level: A price level where selling is thought to be strong enough to prevent the price from rising further.
  17. Support Level: A price level where buying is thought to be strong enough to prevent the price from declining further.
  18. Trend: The direction of the market, or the price of an asset, over a period.
  19. Oscillator: A technical analysis indicator that varies over time within a band (above and below a centerline, or between set levels).
  20. Relative Strength Index (RSI): A momentum oscillator that measures the speed and change of price movements.
  21. MACD (Moving Average Convergence Divergence): A trend-following momentum indicator that shows the relationship between two moving averages of a security’s price.
  22. Stochastic Oscillator: A momentum indicator comparing a particular closing price of a security to a range of its prices over a certain period.
  23. Mean Reversion: A theory suggesting that prices and returns eventually move back towards the mean or average.
  24. Momentum: The rate of acceleration of a security’s price or volume.
  25. Overbought: A condition in which an asset is believed to be trading at a level above its intrinsic or true value.
  26. Oversold: A condition in which an asset is believed to be trading at a level below its intrinsic or true value.
  27. Technical Analysis: The study of past market data, primarily price and volume, to forecast future price movements.
  28. Fundamental Analysis: Analyzing a company’s financial statements, health, competition, and markets to make investment decisions.
  29. Chart Patterns: Distinctive patterns formed by the movement of security prices on a chart.
  30. Candlestick Chart: A type of financial chart used to describe price movements of a security, derivative, or currency.
  31. Bar Chart: A graphical representation of financial data that shows the opening, high, low, and closing prices for a specific period.
  32. Line Chart: A chart that displays information as a series of data points called ‘markers’ connected by straight line segments.
  33. Volume: The number of shares or contracts traded in a security or market during a given period.
  34. Liquidity: The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price.
  35. Market Sentiment: The overall attitude of investors toward a particular security or financial market.
  36. Trading Strategy: A fixed plan designed to achieve a profitable return by going long or short in markets.
  37. Risk Management: The process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions.
  38. Leverage: The use of borrowed money to increase the potential return of an investment.
  39. Margin: The amount of capital required in an account to maintain a trade or trades.
  40. Stop-Loss Order: An order placed with a broker to buy or sell once the stock reaches a certain price.
  41. Take-Profit Order: An order placed with a broker to automatically sell a security when it reaches a certain level of profit.
  42. Backtesting: The process of testing a trading strategy on prior time periods.
  43. Optimization: The process of adjusting the parameters of a trading strategy to achieve the best possible performance.
  44. Walk Forward Analysis: A method used in finance to assess the robustness of a trading strategy by moving progressively forward in time and testing the strategy over a series of time segments.
  45. Drawdown: The peak-to-trough decline during a specific recorded period of an investment, fund, or commodity.
  46. Rebalancing: The process of realigning the weightings of a portfolio of assets by periodically buying or selling assets to maintain an original or desired level of asset allocation or risk.
  47. Divergence: When the price of an asset is moving in the opposite direction of a technical indicator, such as an oscillator.
  48. Convergence: When the price of an asset is moving in the same direction as a technical indicator.
  49. Price Target: The projected price level of a financial security stated by an analyst or advisor.
  50. Risk/Reward Ratio: A measure used by investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns.

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