Bollinger on Bollinger Bands

1. Relative Definitions of High and Low are Key

Bollinger Bands are bands drawn in and around the price structure on a chart. Their purpose is to provide relative definitions of high and low; prices near the upper band are high, prices near the lower band are low.

Context is everything. Instead of relying on fixed price levels, Bollinger Bands provide a dynamic framework where "high" and "low" are defined relative to recent price action and volatility. This means that what is considered high in one situation might be considered low in another, depending on the context.

• A stock trading near its upper band is considered relatively high, even if it hasn't reached a historical high price.
• Conversely, a stock near its lower band is relatively low, even if it hasn't reached a historical low price.
• This relative approach allows for more nuanced trading decisions.

Adaptability is crucial. The bands adapt to changing market conditions, widening during periods of high volatility and contracting during periods of low volatility. This adaptability is a key advantage over static price levels or fixed percentage bands.

• The bands are not fixed; they move with the price action.
• This allows for a more dynamic and responsive approach to trading.
• The bands are not just lines on a chart; they are a framework for understanding price action.

Beyond absolutes. This relative approach moves away from the idea of absolute highs and lows, which are often misleading. Instead, it focuses on the current context and the relationship between price and volatility.

• This is a more realistic approach to trading.
• It acknowledges that markets are dynamic and ever-changing.
• It allows for more flexible and adaptable trading strategies.

2. Bollinger Bands Clarify Price Patterns

Bollinger Bands can aid in pattern recognition by providing definitions: high and low, calm or volatile, trending or not—definitions that can be compared from time to time, from issue to issue, and from market to market.

Pattern recognition enhanced. Bollinger Bands help identify and clarify common chart patterns like double tops (M-type) and double bottoms (W-type) by providing a visual framework. The bands highlight when price action is extreme or within a normal range.

• A W-bottom is often characterized by a first low outside the lower band and a second low inside the band.
• An M-top often shows a series of pushes to a high, with each push failing to reach the upper band.
• These patterns are easier to see and interpret with the bands.

Relative highs and lows. The bands help identify relative highs and lows, which are more important than absolute highs and lows. A new low in price may not be a new low relative to the bands, indicating a potential reversal.

• This is a key concept for understanding the power of Bollinger Bands.
• It allows for more nuanced trading decisions.
• It helps to avoid the trap of buying or selling based on absolute price levels.

Beyond traditional patterns. Bollinger Bands can also help identify less common patterns, such as "walking the bands" and "the squeeze," which are not always obvious using traditional chart analysis.

• These patterns are often missed by traders who rely solely on traditional chart analysis.
• Bollinger Bands provide a unique perspective on price action.
• They allow for a more comprehensive understanding of the market.

3. Walking the Bands is a Continuation Signal

During an advance, walking the band is characterized by a series of tags of the upper band, usually accompanied by a number of days on which price closes outside the band.

Sustained trends. "Walking the bands" refers to a situation where price repeatedly touches or closes outside the upper band during an uptrend or the lower band during a downtrend. This is a sign of a strong, sustained trend, not a reversal.

• It is a common mistake to sell when price touches the upper band.
• Walking the bands is a sign of strength, not weakness.
• It indicates that the trend is likely to continue.

Continuation, not reversal. These closes outside the bands are continuation signals, not reversal signals. They indicate that the trend is likely to continue, not that it is about to end.

• This is a key concept for understanding how to use Bollinger Bands.
• It helps to avoid the trap of selling too early.
• It allows for more profitable trading decisions.

Confirmation is key. While walking the bands is a sign of strength, it is important to confirm the trend with other indicators. Volume indicators, such as Intraday Intensity (II) or Accumulation Distribution (AD), can be used to confirm the trend.

• These indicators can help to identify when the trend is losing momentum.
• They can also help to identify potential reversal points.
• They provide a more comprehensive view of the market.

4. Volatility Cycles Drive Trading Opportunities

The most interesting conclusion is that low volatility begets high volatility and high volatility begets low volatility. This is the foundation of The Squeeze.

Volatility is cyclical. Volatility tends to move in cycles, with periods of low volatility followed by periods of high volatility, and vice versa. This cyclical nature of volatility is a key driver of trading opportunities.

• Low volatility periods are often followed by periods of high volatility.
• High volatility periods are often followed by periods of low volatility.
• This cyclical nature of volatility can be used to predict future price movements.

The Squeeze. The "Squeeze" is a situation where volatility has fallen to historically low levels, often indicated by a contraction of the Bollinger Bands. This is a precursor to a period of increased volatility and a potential breakout.

• The Squeeze is a powerful trading signal.
• It indicates that a big move is likely to occur.
• It can be used to identify high-probability trading opportunities.

BandWidth indicator. The BandWidth indicator is used to measure the width of the Bollinger Bands and identify periods of low volatility. It is calculated as (upper band - lower band) / middle band.

• BandWidth is a key tool for identifying The Squeeze.
• It helps to quantify the level of volatility.
• It can be used to time entries and exits.

5. Indicators Confirm or Deny Band Tags

When the chosen indicator confirms a tag of the bands, you do not have a buy or sell signal; you have a continuation signal. When a tag is unconfirmed, expect regression to the mean.

Confirmation is crucial. A tag of a Bollinger Band is not a buy or sell signal in itself. It must be confirmed by an indicator to be a valid signal.

• A tag of the upper band with a strong indicator is a continuation signal.
• A tag of the lower band with a weak indicator is a continuation signal.
• A tag of the upper band with a weak indicator is a sell signal.
• A tag of the lower band with a strong indicator is a buy signal.

Non-confirmation signals. When a band tag is not confirmed by an indicator, it is a sign that the trend may be weakening and a reversal is possible.

• This is a key concept for understanding how to use Bollinger Bands with indicators.
• It helps to avoid the trap of buying or selling based on band tags alone.
• It allows for more accurate trading decisions.

Regression to the mean. When a band tag is not confirmed, expect regression to the mean, meaning that price is likely to move back towards the middle band.

• This is a statistical concept that is often observed in the markets.
• It can be used to predict future price movements.
• It is a key concept for understanding how to use Bollinger Bands with indicators.

6. Volume Indicators are Essential

Volume indicators are the most important group of indicators for the technician. They get right at the heart of the supply-demand equation while introducing an independent variable, volume, into the analytical mix.

Volume precedes price. Volume indicators are based on the idea that volume often precedes price movements. By analyzing volume, traders can gain insights into the underlying supply and demand dynamics of a security.

• Strong volume on up days is a sign of strength.
• Strong volume on down days is a sign of weakness.
• Volume can be used to confirm or deny price trends.

Types of volume indicators. There are several types of volume indicators, including:

• Intraday Intensity (II): Measures the flow of funds based on where price closes in its range.
• Accumulation Distribution (AD): Measures the flow of funds based on the relationship of the open to the close.
• Money Flow Index (MFI): A volume-weighted version of the Relative Strength Index (RSI).
• Volume-Weighted MACD (VWMACD): A volume-weighted version of the Moving Average Convergence Divergence (MACD).

Independent variable. Volume is an independent variable that is not directly related to price. This makes volume indicators a valuable tool for confirming or denying price trends.

• They provide a different perspective on the market.
• They can help to identify hidden strength or weakness.
• They can be used to improve the accuracy of trading decisions.

7. Method I: The Squeeze Anticipates Volatility

Method I uses low volatility to anticipate high volatility.

Volatility breakout system. Method I is a volatility breakout system that uses The Squeeze to identify periods of low volatility and then looks for a breakout to initiate a trade.

• It is based on the idea that low volatility is often followed by high volatility.
• It is a simple but effective trading strategy.
• It can be used in a variety of markets and time frames.

The Squeeze is the key. The Squeeze is a period of low volatility, indicated by a contraction of the Bollinger Bands. This is a precursor to a potential breakout.

• The Squeeze is a powerful trading signal.
• It indicates that a big move is likely to occur.
• It can be used to identify high-probability trading opportunities.

Trading the breakout. Once a Squeeze is identified, a trade is initiated when price breaks out of the trading range, either above the upper band or below the lower band.

• A stop-loss order is used to limit potential losses.
• A trailing stop can be used to lock in profits.
• The opposite band can be used as a target.

8. Method II: Trend Following with Confirmation

Method II uses confirmed strength to anticipate the beginning of an uptrend or confirmed weakness to anticipate the beginning of a downtrend.

Trend following approach. Method II is a trend-following system that uses Bollinger Bands and an indicator to identify the beginning of a new trend.

• It is based on the idea that trends tend to persist.
• It is a simple but effective trading strategy.
• It can be used in a variety of markets and time frames.

Confirmation is key. A trade is initiated only when price is approaching the upper band and an indicator, such as MFI, is also showing strength, or when price is approaching the lower band and an indicator is showing weakness.

• This confirmation helps to avoid false signals.
• It increases the probability of a successful trade.
• It provides a more robust approach to trend following.

Trading the trend. Once a trend is identified, a trade is initiated in the direction of the trend.

• A stop-loss order is used to limit potential losses.
• A trailing stop can be used to lock in profits.
• The opposite band can be used as a target.

9. Method III: Reversal Trading with Divergence

Method III anticipates reversals in two ways: by looking for weakening indicator readings accompanying a series of upper band tags or by looking for strengthening indicator readings accompanying a series of lower band tags.

Anticipating reversals. Method III is a reversal trading system that uses Bollinger Bands and indicators to identify potential turning points in the market.

• It is based on the idea that trends eventually reverse.
• It is a more aggressive trading strategy than Method II.
• It can be used to identify high-probability reversal points.

Divergence is key. A trade is initiated when price is making new highs or lows, but an indicator is not confirming the move. This divergence is a sign that the trend may be weakening and a reversal is possible.

• A tag of the upper band with a negative indicator is a sell signal.
• A tag of the lower band with a positive indicator is a buy signal.
• These signals are often more reliable than simple band tags.

Trading the reversal. Once a reversal is identified, a trade is initiated in the opposite direction of the trend.

• A stop-loss order is used to limit potential losses.
• A trailing stop can be used to lock in profits.
• The middle band can be used as a target.

10. Bollinger Bands Normalize Indicators

Normalizing indicators with Bollinger Bands allows the indicator to be included in trading systems in an adaptive manner unobtainable before.

Relative indicator levels. Bollinger Bands can be used to normalize indicators, providing a relative definition of high and low for the indicator itself. This allows for a more adaptive approach to using indicators.

• Instead of relying on fixed levels, such as 70 and 30 for RSI, the bands define what is overbought and oversold.
• This is a more dynamic and responsive approach to using indicators.
• It allows for more accurate trading decisions.

%b for indicators. The %b formula can be used to normalize indicators, creating a new indicator that ranges from 0 to 1, with 0.5 at the middle band.

• This allows for a more consistent comparison of different indicators.
• It makes it easier to integrate indicators into trading systems.
• It provides a more intuitive way to interpret indicator readings.

Adaptive approach. By normalizing indicators with Bollinger Bands, traders can create systems that adapt to changing market conditions.

• This is a key advantage over static indicator levels.
• It allows for more robust and reliable trading systems.
• It provides a more comprehensive view of the market.

11. Day Trading Requires Specific Chart Setups

Bollinger Bands are widely used in the daytrading community. They are used on everything from tick charts on up, and they are used in many different ways.

Short-term focus. Day trading requires a different approach to chart analysis than longer-term trading. Day traders typically use shorter time frames, such as tick charts, 1-minute charts, or 5-minute charts.

• These shorter time frames allow for more precise entry and exit points.
• They also require a more active approach to trading.
• They are not suitable for all traders.

Robust bars. It is important to choose a bar length that is robust, meaning that the bars are not too short and that they reflect the underlying price action.

• If the bars are too short, they will be too noisy and difficult to interpret.
• If the bars are too long, they will miss important price movements.
• The goal is to find a bar length that provides a clear and accurate picture of the market.

Bollinger Bands for day trading. Bollinger Bands can be used in a variety of ways for day trading, including:

• Identifying volatility breakouts after a Squeeze.
• Identifying overbought and oversold conditions.
• Identifying potential reversal points.
• Confirming trends with volume indicators.

Last updated: January 27, 2025