Skip to content

Tales From The Trenches: A Simple Bollinger Band® Strategy

I write this not to discredit or credit trading with bands, just to inform you of how bands are perceived in the trading community. 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. Middle of the Bands. Investors must identify any sign of downtrends early enough to protect their investments. However, by having the bands, you can validate that a security is in a flat or low volatility phase, by reviewing the look and feel of the bands. The selling continued well past the day the stock was purchased and the stock continued to close below the lower band for the next four trading days.

Bollinger bands use a statistical measure known as the standard deviation to establish where a band of likely support or resistance might lie. This is a specific utilisation of a broader concept known as a volatility channel.

Navigation menu

One particular Bollinger Bands Strategy that I use when volatility is decreasing in the markets is the Squeeze entry strategy. The Squeeze strategy is based on the idea that once volatility decreases for extended periods of time the opposite reaction typically occurs and volatility expands greatly once again.

When volatility expands markets usually begin trending strongly in one direction for a short period of time. The Squeeze begins with the Band-Width making a 6 month low. In this example you can see IBM stock reaching the lowest level of volatility in 6 months. Notice how the price of the stock is barely moving at the time the 6 month Band-Width Low Is Reached. In this example you can see how IBM stock breaks outside of the upper Bollinger Band immediately after the stocks Band-Width level reached 6 month low.

In this example you can see how Apple Computers reaches the lowest Band-Width level in 6 months and one day later the stock breaks outside of the upper band. This is the type of set ups you want to monitor on a daily basis when using the Band-Width indicator for Squeeze set ups. Notice how the Band-Width begins to increase quickly after reaching the 6 month low level.

The price of the stock will usually begin moving higher within a few days of the 6 month Band-Width low. The Squeeze is one of the simplest and most effective methods for gauging market volatility, expansion and contraction. Always remember that markets go through different cycles and once volatility decreases to a 6 month low, a reversion usually occurs and volatility begins to go up once again.

Usually, once a lower band has been broken due to heavy selling, the price of the stock will revert back above the lower band and head toward the middle band. This is the exact scenario this strategy attempts to profit from. The strategy calls for a close below the lower band, which is then used as an immediate signal to buy the stock the next day. This presented a clear signal that the stock was in oversold territory. The next trading day was not until December 26, which is the time when traders would enter their positions.

This turned out to be an excellent trade. December 26 marked the last time Intel would trade below the lower band. This is a textbook example of what the strategy is looking for. While the price move was not major, this example serves to highlight the conditions that the strategy is looking to profit from.

For related reading, see Profiting From The Squeeze. NYX was clearly in oversold territory. Following the strategy, technical traders would enter their buy orders for NYX on June This is the ideal scenario that the strategy is looking to capture.

Opening a position on June 13 allowed traders to enter right before the turnaround. In a different example, Yahoo broke the lower band on December 20, The strategy called for an immediate buy of the stock the next trading day.

Just like in the previous example, there was still selling pressure on the stock. While everyone else was selling, the strategy calls for a buy. That proved correct, as Yahoo soon turned around. On December 26, Yahoo again tested the lower band, but did not close below it. This would be the last time that Yahoo tested the lower band as it marched upward toward the upper band.

As we all know, every strategy has its drawbacks and this one is definitely no exception. In the following examples, we'll demonstrate the limitations of this strategy and what can happen when things do not work out as planned. When the strategy is incorrect, the bands are still broken and you'll find that the price continues its decline as it rides the band downward.

Unfortunately, the price does not rebound as quickly, which can result in significant losses. In the long run, the strategy is often correct, but most traders will not be able to withstand the declines that can occur before the correction.

The selling pressure was clearly in oversold territory. The strategy called for a buy on the stock the next trading day. Like the previous examples, the next trading day was a down day; this one was a bit unusual in that the selling pressure caused the stock to go down heavily. The selling continued well past the day the stock was purchased and the stock continued to close below the lower band for the next four trading days.

Finally, on March 5, the selling pressure was over and the stock turned around and headed back toward the middle band.

What Are Bollinger Bands

Bollinger Bands® consist of three bands - an upper, middle and lower band - that are used to spotlight extreme short-term prices in a security. The upper band represents overbought territory, while the lower band can show you when a security is oversold. Most technicians will use Bollinger Bands® in conjunction with other analysis tools to get a better picture of the current state of a market or security. The most comprehensive guide for how to trade with bollinger bands. Learn cutting edge bollinger bands strategies for bitcoin, futures and guide has videos, real-life trading examples and custom visuals to demystify and answer all of your questions related to the indicator. Companies like Forbes suggest that the use of Bollinger Bands is a simple and often an effective strategy but stop­loss orders should be used to mitigate losses from market pressure. [10].