If you live under a rock you may not know who John Bollinger is.
For the rest of us, we recognize him for being the innovator behind the technical indicator, Bollinger Bands, which has been around since 2001.
No matter the time frame, style of trading, or markets being analyzed…
Bollinger Bands can tackle the toughest jobs with ease!
Regardless If you are new to trading or a savvy vet— you are going to lose money at some point.
As traders we rely on tools to help us make better, faster, and more informed decisions.
There are thousands of technical indicators you can select from. However, there are only a handful that can help you predict future stock prices.
This is where Bollinger Bands really stand out from the rest.
They are truly unbelievable.
Don’t believe me just yet?
Give me less than five minutes…and I bet I can change your mind… not only turn you into a fan but even a practitioner.
Bollinger Bands are a bit of a mixed bag around here.
Many traders swear it is the key to their success while others avoid it like the plague.
This article is aimed to help beginning and experienced traders learn a highly effective strategy they can use immediately!
The beauty about this indicator is that it encapsulates the price movement of a stock.
Meaning, it provides relative high and low boundaries the stock should move inside.
The Bollinger Bands are based on the 20-period standard moving average and the upper and lower bands are a measure of volatility.
How they are calculated:
Middle Band = 20 period moving average
Upper Band = Middle Band + 2 standard deviations
Lower Band = Middle Band – 2 standard deviations
Here is a standard 20 period Bollinger Band plotted on the SPY’s:
The Bollinger Band can help you:
- Identify potential overbought/oversold areas
- Identify the volatility of the markets
It’s important to remember…
When price is near the top of the Bollinger Band its “expensive” because it’s 2 standard deviations above its 20 period average.
And when the price is near the bottom of the bollinger band its “cheap” because its 2 standard deviations below its 20 period average.
Here’s an example:
I must warn you…
Don’t just buy whenever it’s cheap and sell whenever it’s expensive.
You will be buying (or selling) into momentum breakouts and will end up stepping in front of that train you have been warned about before.
That means don’t start going long when price reaches the lower bands.
… or this may happen to you.
You definitely don’t want to be selling into that type of momentum.
So what do you do?
If you want to have a high probability of success, you need a few confluence factors coming together before you trade the bands.
- Look to go long the lower band in an uptrend
- Look to go long the lower band after a reversal candle appears below the bands
- Use the lower bands with other complementary technical patterns
Now that the basics are covered, let’s get into details on how to turn the Bollinger Bands into a trading system.
… I mean that’s why we are all here today, right?
Mean Reversion With Bollinger Bands
Bollinger bands are an extremely versatile indicator used by many traders around the globe and is built into almost every trading application on the market.
This indicator is used to help traders time the market and find optimal entry and exit prices on their trades.
Many traders even combine Bollinger Bands with their favorite patterns, such as double tops and double bottoms.
Some of the most common reversal strategies are :
- Bollinger Band Double Touch pattern
- Bollinger Band Ping-Pong pattern
- Bollinger Band Gap Reversal pattern
Bollinger Band Double Touch Pattern
A Bollinger Band Double Touch pattern always starts with a double bottom or double top in the stock chart.
“Bollinger Bands can be used in pattern recognition to define/clarify pure price patterns such as “M” tops and “W” bottoms, changes in momentum, and short term reversons.”
– John Bollinger
This pattern sets up in 2 steps.
- Identify the double touch (double bottom) pattern on the chart.
- Confirm price lows outside bands
- Verify that price closes inside bands
Many Bollinger Band technicians look for a retest bar to print inside the lower band.
This indicates that the downward pressures in the stock have subsided and the buyers are now in control.
Pro Tip: Sometimes you can skip on # 3 but be careful that Bollinger Bands are not indicating potential momentum to the downside.
In the above chart, you can identify the 3 main points to look for in the reversal pattern.
Let’s step through what played out in this trade.
- The price sold off in August below the lower bands
- Price created a technical support level
- Price came back down to support zone and price traded below Bollinger Bands
Those three points have indicated both the technical support zone and the Bollinger Band support zone aligned.
Once this happened the next bar traded back inside the Bollinger Bands indicating the bulls were back in control and a long trade was safe to take landed over a 10% gains in that trade.
Bollinger Band Ping-Pong pattern
This strategy is for traders who like to trade scalpy and quick movements in a stock… (and yes, all these strategies apply to ANY timeframes you like to trade with little tweaking.)
Now that we covered the Snap Back pattern using Bollinger Bands, let’s take a look to apply the same techniques to a similar pattern.
The theory behind this strategy is that we are waiting for the markets to bounce off the bands and head back towards the middle moving average.
Remember, if a stock trades at the bands, its extended well past its average and theoretically should revert back to the average.
The beauty about this simple strategy is that it identifies clear entry and exit levels, leaving the trader to do what he does best. Just trade.
Let’s take a look at what I mean exactly.
In this example above there are two trades that set up. There was one long and one short trade on the SPY’s.
Pro Tip: A Stop And Reverse trading style for this strategy is a great way to boost even more profits.
This strategy is not a huge home-run hitter, but instead a singles and doubles approach to trading.
This requires a dedicated, rinse-and-repeat mentality, but it produces some of the most wildly profitable and consistent systems out there.
By not asking for much, you can safely pull money out of the market like an ATM on a consistent basis.
The key here is waiting for the Bollinger Bands to be broken. Jumping early into a trade can turn out to be a costly mistake if the Bollinger Bands don’t act as support or resistance.
Bollinger Band Gap Reversal pattern
Another simple and effective trading method is to look for a trade fading stocks after the move beyond the bands.
Let’s take a look at an example SPY trade using the hourly chart.
In the image above, you can easily notice a similarity between the two gaps.
The common element is that the price fades back to the opposite direction!
For example, instead of buying a stock that gaps below its lower band, wait to see how that stock performs. This same approach goes for taking a short position as well.
If a stock gaps below its lower band, it is best to wait to see if the stock can show signals of strength before going long.
Likewise, if the stock gaps up and closes near its highs, it’s best to wait for weakness to be seen.
In the above example:
For the long:
- The chart started to show strength shortly after the gap lower and began heading higher.
- Once strength has been identified, you can place a long position on the stock with two target areas : (1) the middle band, and (2) the upper band.
For the short:
- The chart started to show weakness shortly after the gap higher and began heading lower. (Did you notice that this coincided with a double top pattern, too!)
- Once the weakness has been identified, you can place a short position on this stock with two target exit areas : (1) the middle band, and (2) the lower band.
This article covered three basic mean reversion strategies that are based on Bollinger Bands.
3 of the most common reversal strategies are :
- Bollinger Band Double Touch pattern
- Bollinger Band Ping-Pong patter
- Bollinger Band Gap Reversal pattern
Bollinger bands are an extremely versatile indicator used by many professional traders that helps to find the optimal entry and exit prices on their trades.
What you learned:
- Bollinger Bands identify areas of “cheap” and “expensive” prices
- Confluencing indicators to give you the highest probability trades
- Using lower time-frames to give you smooth and consistent returns