Have you heard of the bollinger bands trading strategy? Among the many different indicators one could choose to analyze charts with, there has been one that stands out to me.
I'm often reminded that there is no perfect set of indicators to put on a chart that will work perfectly for everyone. If only it could be that easy right?
A Bollinger Bands Trading Strategy
- I know many traders and almost all of them each have a certain set of indicators that work for them individually. Some of the more seasoned traders I know can trade on price action and patterns alone. Moving averages are often used and I still use them to get an idea where key support and resistance areas are within a long term trend but I don't like to day trade with them. Therefore, lets look at a bollinger bands trading strategy.
Having a set of indicators that make sense to you is imperative no matter what level of trading experience you have.
Having a clean and uncluttered chart is key when you are flipping through a bunch of charts trying to find a quality setup or chart pattern.
It's especially apparent when you start looking into time frames of less than 1 hour. That is when I remove all of my moving average indicators and deploy my trusty Bollinger Bands.
1. How Do You Use Bollinger Bands for Day Trading?
The Bollinger Bands trading strategy have always served me well, especially with day trading. They allow me to keep a simple and clean chart; which allows one to see price action clearly while giving very obvious buy and sell signals.
They work really well with a secondary indicator like MACD or RSI. But you may have to modify the settings to work with different time periods. For a while I used both but before long I found that FSTO is self adjusting and smooth which works great for me.
FSTO or the Fast Stochastic Oscillator is a very basic looking secondary indicator but it actually has quite a bit of math behind it. We can get into that math later. For now we just need to know how to use it.
In a nutshell FSTO essentially indicates the momentum of price. The idea is that the momentum of price changes direction before price changes direction.
The indicator is range bound so it also indicates both bearish and bullish divergence. Divergence in theory will precede reversals. Think of it as a way to verify the buy and sell signals on our Bollinger chart.
The range is where we can find our signals. Above 80 is the overbought zone, 50 is the middle and below 20 is the oversold zone. D is your actual buy and sell indicator line and K is used to emphasize divergence indicating a trend change.
2. Dissecting the Bands
Bollinger Bands are actually really simple. In fact I believe that they work like training wheels for those who will eventually learn how to trade on price action alone.
I still use them because I like it easy. I can spot trends, patterns, reversals, pivots and support/resistance zones at a glance.
Let's start in the middle. The middle band is just a 20 period moving average or the average of the last 20 candles on your chart no matter what time frame you are looking at.
The upper band is 2 standard deviations above the middle band and the lower band is 2 standard deviations below the middle band. The reason for the deviations is to indicate volatility.
The volatility is relative to the distance between the upper and lower bands and the advantage is that it gives you a range of volatility. Price action (candles) that stay within this range are pretty normal and are used to verify the trend.
Candles that leave the upper or lower band are known as tags and pokes. Solid candles and candles with short wicks that either go slightly above the upper band or slightly below the lower band are pretty good indicators of strength in the trend.
This is known as tagging the band. A series of solid candles that either periodically or consistently tag the upper band or the lower band verify a strong trend on any time frame.
This is known as "walking the band". In a bullish trend "walking the upper band" and in a bearish trend "walking the lower band".
When Should You Use Bollinger Bands?
- Now let's talk about pokes. A candle with a long wick is pretty self explanatory when it comes to price action assuming you learned a little bit about candles. They are not sharp or anything but they can poke any of the three bollinger bands. Price action does not tend to walk the middle band but it does tend to bounce off of it for the most part.
The buy signal will tend to start with a candle wick poking through the lower band and confirmed divergence on your secondary indicator but you want to confirm the signal with the next candle.
You want to see the next candle with a solid body that starts at or above the lowest part of the solid part of the previous candle with a wick. The previous candle can also be a doji.
Sometimes the previous can even be a solid candle but you will want to be pretty intimate with your secondary indicator in that case. Rarely it can be a series of ascending dojis which are often followed by a big move.
When a candle has a long wick above it and it pierces the upper band it is known as an upper band poke. This is often an indication of weakness in the trend and is typically easy to verify with your secondary indicator.
You also have a third indicator, volume. If volume candles are getting shorter and or turning red you have further indication that a reversal is likely. If everything checks out that's your sell signal.
1. The Middle Band
Now for the middle band. The middle band can act as resistance in a bearish trend, support in a bullish trend and can also act as a really short term pivot.
This is where your candlestick education really comes into play. A volatile trend can often bounce candles between the middle band and either the upper band or the lower band depending on trend direction.
Pay attention to the 5 and 15 minute time frames too. Often a choppy 1 minute chart will be much smoother on a 5 or 15 minute chart. You can also spot patterns more easily on those time frames. When in doubt zoom out and look left. Reversal patterns are key.
More often than not the candles that bounce off the middle band will have at least a small wick that pokes it. If a solid candle appears to be tagging the middle band it will often break through the middle band.
This happens mostly after a confirmed trend reversal after either an upper or lower band poke. That is when the middle band becomes a pivot point.
The candles after that will sometimes be a solid candle that straddles the middle band but watch for a wick. The wick will likely seal the deal. On a rare occasion that next candle can be a doji.
In this case watch for your secondary indicator divergence to flip. When that happens what you think is a reversal can become a pullback instead.
2. Trading Signals and the Bollinger Bands Trading Strategy
Trading signals on a bollinger chart are not always clear on choppy charts. There is a solution. Heikin Ashi candles. For the most part your FSTO secondary indicator will still be useful on low volume equities but your standard candles will not resemble anything useful.
Heikin Ashi candles will smooth out the chop and still allow you to utilize your bollinger bands. For traders with a big account liquidity on low volume can certainly be an issue.
For the traders starting out with a small account, low volume equities are great slow motion practice for bollinger band day trading. Heikin Ashi candles make it possible.
In fact, you can use the bollinger bands trading strategy with our weekly stock signals.
The Bottom Line
I learned how to day trade with the bollinger bands trading strategy first. However, I found them to be useful on any time frame.
This is really cool because you can back up your other indicators on daily and weekly charts when moving averages aren't giving you a clear answer.
As a rule of thumb I never mix moving averages with bollinger bands, nobody wants to see that mess. Stay tuned, I've got a lot to write about.