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As for the stop-loss points, putting the stop just above the swing high will practically assure the trader is stopped out, as the price will often make many forays at the recent top as buyers try to extend the trend. By using the volatility of the market to help set a stop-loss level, the trader avoids getting stopped out and is able to remain in the short trade once the price starts declining.
A squeeze occurs when the price has been moving aggressively then starts moving sideways in a tight consolidation. A trader can visually identify when the price of an asset is consolidating because the upper and lower bands get closer together. This means the volatility of the asset has decreased. After a period of consolidation, the price often makes a larger move in either direction, ideally on high volume. Expanding volume on a breakout is a sign that traders are voting with their money that the price will continue to move in the breakout direction.
When the price breaks through the upper or lower band, the trader buys or sells the asset, respectively. A stop-loss order is traditionally placed outside the consolidation on the opposite side of the breakout. Here is a brief look at the differences, so you can decide which one you like better.
One technical indicator is not better than the other; it is a personal choice based on which works best for the strategies being employed. Traders can also add multiple bands, which helps highlight the strength of price moves. Another way to use the bands is to look for volatility contractions.
These contractions are typically followed by significant price breakouts, ideally on large volume. While the two indicators are similar, they are not exactly alike. Bollinger Bands. Fundamental Analysis. Technical Analysis Basic Education. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Table of Contents. Calculation of Bollinger Bands. Overbought and Oversold Strategy. Multiple Bands for Greater Insight. A Tool for Trend Traders and Faders.
Bollinger Bands Squeeze Strategy. Bollinger vs. The Bottom Line. The bands are often used to determine overbought and oversold conditions. Using only the bands to trade is a risky strategy since the indicator focuses on price and volatility, while ignoring a lot of other relevant information. Article Sources. Also, the candlestick struggled to close outside of the bands. Another simple, yet effective trading method is to fade stocks when they begin printing outside of the bands.
For example, instead of shorting a stock as it moves up through its upper band limit, wait to see how that stock performs. If the stock goes parabolic or gaps up and then closes near its low while near the 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 depending on where the stock finds support: 1 upper band, 2 middle band or 3 lower band.
Using the same chart from above, we can see that the rally off the first low created a near term overbought scenario. As you can see from the chart, the first red candle after the highs was a bearish engulfing candle.
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. To the earlier point, price penetration of the bands alone cannot be a reason to short or sell a stock. 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.
It immediately reversed with an engulfing candle pattern, and all the breakout traders were head-faked. 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 red line. 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.
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 often 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 even the best of us. Below is a 5-minute chart of NIO.
Notice how leading up to the morning gap down 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; 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. The below chart depicts this approach.
Below is a snapshot of NIO from October 29, Notice how NIO gapped up over the upper band on the open, had a small retracement back inside of the bands, then later exceeded the high of the first candlestick. These sorts of setups can prove powerful if they end up riding the bands. This strategy is for those of us who like to ask for very little from the markets. Essentially you are waiting for the market to bounce off the bands back to the middle line, which carries a high winning percentage over time.
In this setup, you are not obsessed with getting in a position for it to swing wildly in your favor. Nor are you looking to be a prophet of sorts and try to predict how far a stock should or should not run. By not asking for much, you will be able to safely pull money out of the market on a consistent basis and ultimately reduce the wild fluctuations of your account balance, which is common for traders that take big risks.
The key to this strategy is waiting on a test of the mid-line before entering the position. You can increase your likelihood of placing a winning trade if you go in the direction of the primary trend and there is a sizable amount of volatility. As you can see in the above example, notice how the stock had a sharp run-up, only to pull back to the mid-line.
You would want to enter the position after the failed attempt to break to the downside. You can then sell the position on a test of the upper band. If you have an appetite for risk, you can ride the bands to determine where to exit the position.
First, you need to find a stock that is stuck in a trading range. The greater the range, the better. Now, looking at this chart, you may feel a sense of boredom overcoming you. However, from experience, the traders that take money out of the market when it presents itself, are the ones sitting with a big pile of cash at the end of the day. In the above example, simply buy when a stock tests the low end of its range and the lower band.
Conversely, you sell when the stock tests the high of the range and the upper band. The key to this strategy is a stock having a clearly defined trading range. This way you are not trading the bands blindly but are using the bands to gauge when a stock has gone too far. 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.
So, instead of trying to win big, you just play the range and collect all your pennies on each price swing of the stock. Like anything else in the market, there are no guarantees. No doubt, Bollinger Bands can be a great tool for identifying volatility in a security, but it can also prove to be a nightmare when it comes to newbie traders.
Not exiting your trade can almost prove disastrous as three of the aforementioned strategies are trying to capture the benefits of a volatility spike. For example, imagine you are short a stock that reverses back to the highs and begins riding the bands. What would you do? While there is still more content for you to consume, please remember one thing — you must have stops in place! This is the important question for anyone reading this article. But it is such a tough question to answer. For me, there are two strategies that I prefer to use — 5 and 6.
But we all have different personalities and trading styles. This Strategy will work in very strong markets. It affords you the flexibility of jumping on a hot stock while lowering your risk as you wait for the pullback. I have been a breakout trader for years.
But I will be the first to tell you that most breakouts fail. Not to say pullbacks are without their issues, but you can at least minimize your risk by not buying at the top. Because you are not asking much from the market in terms of price movement. From my personal experience of placing thousands of trades, the more profit you search for in the market, the less likely you will be right. In addition to strategies, there are a few items related to bands I need to cover that will provide you with a full picture of the indicator.
I was reading an article on Forbes, and it highlighted six volatile swings of bitcoin starting from November through March Doing my research, I looked at some of these price swings of Bitcoin in the Tradingsim platform.
During this period, Bitcoin ran from a low of 12, to a high of 16, That kind of money that fast can be hard to grasp. The psychological warfare of the highs and the lows become unmanageable. So, it got me thinking, would applying bands to a chart of bitcoin futures have helped with making the right trade? I indicated on the chart where bitcoin closed outside of the bands as a possible turning point for both the rally and the selloff. You must honestly ask yourself if you will have the discipline to make split-second decisions to time this trade, just right.
The one thing the bands manages to do as promised is contain the price action, even on something as wild as bitcoin. I honestly find it hard to determine when bitcoin is going to take a turn looking at the bands. Bitcoin is just illustrating the harsh reality when trading volatile cryptocurrencies that there is no room for error. I do not trade bitcoin.
But after looking at the most recent price swing using bands, a couple of things come to mind:. Pairing the Bollinger Band width indicator with Bollinger Bands is like combining the perfect red wine and filet mignon. In the previous section, we talked about staying away from changing the settings. Well, if you think about it, your entire reasoning for changing the settings in the first place is in hopes of identifying how a security is likely to move based on its volatility.
A much easier way of doing this is to use the Bollinger Bands width. In short, the BB width indicator measures the spread of the bands compared to the moving average to gauge the volatility of a stock. Essentially, you have an actual reading of the volatility of a security.
You can then look back over months or years to see if there are any repeatable patterns of how price reacts when it hits extremes. To see this in action, look at the below screenshot using both the Bollinger Bands and Bollinger Band width. Notice how the Bollinger Bands width tested the. The other point of note is that on each prior test, the high of the indicator made a new high, which implied the volatility was expanding after each quiet period. As a trader, you need to separate the idea of a low reading with the Bollinger Bands width indicator with the decrease in price.
Remember, Bollinger Band width is informing you that a pending move is coming, the direction and strength are up to the market. If you had just looked at the bands, it would be nearly impossible to know that a pending move was coming. You would have no way of knowing that. This is always a fun question: Can an indicator somehow provide you clues of a major price swing? The above chart is of the E-Mini Futures. I want to dig into the E-Mini because the rule of thumb is that the smart money will move the futures market which in turn drives the cash market.
Looking at the chart of the E-mini futures, the peak candle was completely inside of the bands. Other than the fact the E-mini was riding the bands for months, how would you have known there was a big break coming? Remember in Chapter 4, the Bollinger Band width can give an early indication of a pending move as volatility increases.
In the above example, the volatility of the E-Mini had two breakouts prior to price peaking. First, the Bollinger Band width had been coiling for approximately five months before breaking out.
Another forex trading strategy to work around this is to. Bollinger Bands® are a type of chart indicator for technical analysis and have become widely used by traders in many markets, including stocks, futures. Bollinger Bands, a technical indicator developed by John Bollinger, are used to measure a market's volatility and identify “overbought” or “oversold” conditions.