In the example above, you seethat the dark-cloud cover acted as a Bollinger Band squeeze indicator as the price action that followed reached the take profit and some more.
Reversal Patterns with Bollinger Bands Indicator
However, recently it has been proved that using an exponential moving average EMA is more lucrative for riding a trend. A typical Bollinger Bands strategy is to look for a break when the two standard deviations are moving away from each other. There are multiple ways to use the indicator. The most popular one being to look for a breakout when the bands are becoming closer to one another. This indicates a period of low volatility and a break is imminent.
Contrary to the general belief, the Forex market spends most of the time in consolidation. Over seventy percent of the time, prices are moving in a range. Doing that would result in being on the right side of the market for over six months and avoid the noise caused by the fundamental news. There are two ways to deal with an underlying trend with Bollinger Bands strategies. Both are the result of knowing how to use Bollinger Bands. One is to use the MBB line as entries in the direction of the trend.
The red arrows in the chart below show bearish Bollinger Bands signals given by the Bollinger Bands settings mentioned earlier. The big red candle caused by the U. Presidential election and the Trump effect is nothing but another opportunity that shows how to read Bollinger Bands indicator. As for the take profit, a classical one would be when the price is reaching the opposite Bollinger Band.
In this example, as the underlying trend is bearish, the opposite band would be the LBB. For the trades illustrated so far, the target area or the exit point are highlighted in the picture above. The key to this Bollinger Bands technical analysis approach is to wait for the candle to close. Of course, the examples above use the daily time frame, but the same principle can be successfully used on lower time frames too. Therefore, the drawdown, in case the Bollinger Bands parameters are set on a lower time frame, is not that big like on the daily chart.
However, the idea regarding how to interpret Bollinger Bands indicator is the same, no matter the time frame used. So far, we saw the Bollinger Bands interpretation on a breakout strategy. It is based on how to calculate Bollinger Bands and interpret the standard deviations that indicate how volatile a market is. However, does a Bollinger Bands reversal strategy exists? The answer is yes, and for this, we need to look for reversal pattern that forms when the price is reaching the extremes UBB and LBB.
The perfect reversal patterns are the Japanese candlestick techniques. A great way to learn how does Bollinger Bands work is to look for reversal patterns given by Japanese candlestick techniques. These are the most representatives and are forming all the time.
Like anything related to trading, there is a trick here too. You should ignore all other reversal patterns that are not touching the two volatility lines. The example above shows a dark-cloud cover forming at the end of a bullish trend, with both candles that are part of the reversal pattern touching the UBB volatility line.
This is enough to take a short trade. As a take profit and finding your risk-reward ration, you can use the length of the dark-cloud cover To calculate it, simply measure the highest and the lowest point in the dark-cloud cover pattern.
Then multiply it by 2. The stop loss should be the highest point of the reversal pattern. You can use a bigger risk-reward ratio, but that would not be a realistic approach. In the example above, you seethat the dark-cloud cover acted as a Bollinger Band squeeze indicator as the price action that followed reached the take profit and some more.
The same is valid for the hammer reversal pattern that follows. By definition, a hammer is a bullish reversal pattern, meaning a bearish trend must be in place. Such a tutorial is like a trading plan that has both entry and exit levels.
And it is a must have for every trader interested in mastering the Bollinger Bands width indicator. Another great way to use Bollinger Bands is to integrate the indicator with the Elliott Waves theory. This is one of the most popular trading theories that exists. After all, what is Bollinger Bands indicator if not one that looks for reversals or continuation patterns when crowds are on the other side of the market?
This is exactly what the Elliott Waves theory is for. A bullish trend, therefore, will have five waves to the upside, corrected with three waves to the downside. The key to understanding how Elliott Waves works is to know that even within the five-waves that are defining a bullish move, there are two waves that move in the opposite direction. Bollinger Bands trading works in both the five-wave structure and the three-wave structure that corrects it.
According to Elliott, a 5-wave structure is impulsive and is labeled with numbers. The name of the three-wave structure is a corrective move and is labeled with letters. This should happen based on the letters or numbers that appear on the screen.
The Bollinger Bands bandwidth acts both as a reversal pattern, when fake breakouts appear, as well as a continuation pattern. The example below is relevant. That means that one wave should stand out of the crowd, to be the longest. Typically, that wave is the 3 rd one, but this is not mandatory. Traders have the tendency to look for a pullback to come, as the second wave. And then to buy that pullback if the impulsive wave or the five-wave structure is bullish or to sell a spike if the impulsive wave or the five-wave structure is bearish.
Such a retracement is almost always coming after a breakout that suggests volatility is on the rise and the ranging environment ended.
The chart above shows a flat pattern labeled a-b-c in magenta. Elliott found that the c-wave in a flat is always an impulsive move. Therefore, it is obvious that the waves within the c-wave must be labeled with numbers. However, a closer look shows that the first bearish breakout appeared way before the start of the c-wave. It formed when the a-wave in magenta ended. The chart below shows the opportunities given by Bollinger Bands if used in conjunction with a corrective wave within the Elliott Waves theory.
While bands do a great job of encapsulating price movement, it only takes one extremely volatile stock to show you the bands are nothing more than man's failed attempt to control the uncontrollable. While there is still more content for you to consume, please remember one thing - you must have stopped in place!
Let me help you out if you are confused - kill the trade! While bandsdo a great job of encapsulating price movement, it only takes one extremely volatile stock to show you the bands are nothing more than man's failed attempt to control the uncontrollable. Strategy 5 - Snap back to mthe iddle band, will work in very strong markets.
I have been a breakout trader for years and let me tell you that most breakouts fail. Not to say pullbacks are without their own issues, but you at least minimize your risk by not buying at the top. Shifting gears to strategy 6 - Trade Inside the Bands, this approach will work well in sideways markets.
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. Don't worry, I'm not about to go on a history lesson on cryptocurrencies with details of where David Chaum went to college.
I was reading an article on Forbes, and it highlighted 6 volatile swings of bitcoin starting from November through March So, I wanted to do my own research and I looked at the most recent price swings of Bitcoin in the Tradingsim platform.
Let's look at the period of December 22, ,to December 27, During this period, Bitcoin ran from a low of 12, to a high of 16, Let's unpack this a little further. Do you realize that these gains were largely made over 3 days' worth of trading? I am getting a little older now and hopefully a little wiser and that kind of money that fast, I have learned is almost impossible for me 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. But let's be honest here, this is a minute chart of a highly volatile security. You must honestly ask yourself will you 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. It's not that the bands are doing anything wrong or not working. Bitcoin is just illustrating the harsh reality when trading volatile cryptocurrencies that there is no room for error.
I personally 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 meat combo you can find.
In the previous section, we talked about staying away from changing the settings. Well, if you really 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 to the moving average to gauge the volatility of a stock. Well, now 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.
Still, don't believe me? Look at the below screenshot using both the Bollinger Bands and Bollinger Band width. Notice how the Bollinger Band 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. 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 just another example of why it's important to pair Bollinger Bands with other indicators and not use it as a standalone tool.
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? Now that I have built up tremendous anticipation, let's see if there is a way to identify an edge.
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. If that wasn't enough to convince you, then the second break above the 8-month swing high of the Bollinger Band width was your second sign.
After these early indications, the price went on to make a sharp move lower and the Bollinger Band width value spiked. The inspiration for this section is from the movie Teenage Mutant Ninja Turtles, where Michelangelo gets super excited about a slice of pizza and compares it to a funny video of a cat playing chopsticks with chopsticks.
Does anything jump out that would lead you to believe an expanse in volatility is likely to occur? Let me tell you, when you are trading in real-time, the last thing you want to do is come late to a party. More times than not, you will be the one left on cleanup after everyone else has had their fun. It was very subtle, but you can see how the bands were coiling tighter and tighter from September through December. During this time, the VIXY respected the middle band.
There was one period in late November when the candlesticks slightly jumped over the middle line, but the candles were red and immediately rolled over. However, in late January, you can see the candlesticks not only closed above the middle line, but also started to print green candles. Now, one could argue that this wasn't enough information to make a trading decision. That is a fair statement. You would need a trained eye and have a good handle with market breadth indicators to know that this was the start of something real.
There is the obvious climactic volume which jumps off the chart, but there was a slight pickup in late January, which was another indicator that the smart money was starting to cash in profits before the start of spring break. This gives you an idea of what topics related to bands are important to other traders according to Google. Why is this important? It's safe to say bands is probably one of the most popular technical indicators in any trading platform.
If memory serves me correctly, Bollinger Bands, moving averages and volume were likely my first taste of the life. Well as of today, I no longer use bands in my trading. That doesn't mean they can't work for you, but my trading style requires me to use a clean chart. Therefore, the more signals on the chart, the more likely I am to act in response to said signal.
This is where the bands expose my trading flaw. For example, if a stock explodes above the bands, what do you think is running through my mind? You guessed right, sell! The stock could just be starting its glorious move to the heavens, but I am unable to mentally handle the move because all I can think about is the stock needs to come back inside of the bands. Instead of taking the time to practice, I was determined to turn a profit immediately and was testing out different ideas.
I decided to scalp trade. I would sell every time the price hit the top bands and buy when it hit the lower band. It's really bad, I know. From what I remember, I tried this technique for about a week, and at the end of this test, I had made Tradestation rich with commissions. The key flaw in my approach is that I did not combine bands with any other indicator.
This left me putting on so many trades that at the end day, my head was spinning. Flashback to , when I was just starting out in day trading; I had no idea what I was doing. One of the first indicators I put to the test was Bollinger Bands. It's one of the most popular indicators. Al Hill Click to tweet. At the end of the day, bands are a means for measuring volatility. So, it's not something you can just pick up and use for buy and sell signals. Just as you need to learn specific price patterns, you also need to find out how bands respond to certain price movements.
This level of mastery only comes from placing hundreds, if not thousands of trades in the same market. The thing that surprised me is that I couldn't find many other famous authors or experts in the space. I'm not sure if this is because there aren't many people interested or if other traders stay out of the bands arena because John is so actively evangelizing the bands.
The books I did find were written by unknown authors and honestly, have less material than what I have composed in this article. The other hint that made me think these authors were not legit, is their lack of the registered trademark symbol after the Bollinger Bands title, which is required by John for anything published related to Bollinger Bands.
Conversely, when I search on Elliott Wave, I find a host of books and studies both on the web and in the Amazon store. I am still unsure what this means exactly. With there being millions of retail traders in the world, I have to believe there are a few that are crushing the market using Bollinger Bands. I just struggled to find any real thought leaders outside of John. I write this not to discredit or credit trading with bands, just to inform you of how bands are perceived in the trading community.
Bollinger Bands work well on all time frames. Remember, price action performs the same, just the size of the moves are different.
Without a doubt, the best market for Bollinger Bands is Forex. Currencies tend to move in a methodical fashion allowing you to measure the bands and size up the trade effectively. Next, I would rank futures because again you can begin to master the movement of a particular contract. Last on the list would be equities.
The captain obvious reason for this one is due to the unlimited trading opportunities you have at your fingertips. It's one thing to know how the E-mini contract will respond to the lower band in a five-day trading range. It's another thing to size up one stock from another in terms of how it will respond to the bands.
I hope you have enjoyed reading this article. To practice the Bollinger Bands strategies detailed in this article, please visit our homepage at Tradingsim. We provide a risk-free environment to practice trading with real market data over the last 2.
Free Trial Log In. Middle of the Bands. Bitcoin Holiday Rally. Bitcoin with Bollinger Bands. Big Run in E-Mini Futures. Who Knew A Top was In? Al Hill is one of the co-founders of Tradingsim.