Bollinger Bands - A Long Overdue Second Date!
Thursday, November 12, 2009 | Mark Deaton Is this Spam?90% of all traders using Bollinger band never go beyond the first date to discover the true power and predictability that this indicator has to offer. New traders and veterans alike are totally unaware of some of the secrets I'm about to reveal to you right here in this short but revealing article.
As you may know Bollinger bands consists of a pair of Bands around price action and a moving average, usually a 21 period moving average. The bands themselves typically represent 2 standard deviations around price.
This simply allow a trader to see the mean, or moving average, and a distance from price in both directions that represents a 2 standard deviation from the mean. So you have the MIDDLE, and the OUTER limits if you will.
Now, here's what most people know about Bollinger bands. They know that when price closes beyond a band on either side, it is likely to reverse if only for a short time. They also know that if the bands squeeze together tightly around price a likely break-out will occur in one direction or the other.
This is what I mean by the first date. They learn this and move on to the next Holy Grail, never really getting into the meat, or the power that's at their fingertips.
Bollinger Bands - The Meat...
The above methods of using Bollinger bands are strong don't get me wrong, I made a killing in 2006, early 2007 and a big part of 2009 using a simple reversal strategy with Bollinger bands, but a closer look at price action relative to the bands gives you 10 times more insight.
Reversals / Continuations
Funny thing about Bollinger bands is that the reversal and the continuation set-ups are identical. In my opinion this is what frustrates most traders and this is why they never make it to the second date. They have a hard time with the fact that in the heat of the moment they misread whether a continuation or reversal set-up is forming and they more often than not get on the wrong side of the trade.
The fix is understand and observing how the bands react to approaching price action.
Approaching Price Action
The key to your falling in love with Bollinger bands is careful observation of how the bands react to approaching price action. Both bands not just the one being approached. In a nut shell here is the magic formula.
We'll use Bullish reversal's and continuations for this example and the opposite is true for bearish reversals or continuations.
1.) Price approaches the upper band and the upper and lower bands remain flat. Reversal - Likely a sharp reversal to the lower band. Because both bands are flat this will likely be short lived.
2.) Price approaches the upper band and the upper band goes up and the lower band is flat or moving up slightly. Continuation - Price will likely continue up slowly for a time.
3.) Price approaches the upper band and the upper band goes up and the lower band goes down. Continuation - Price will likely move up fast and furious. This is the best continuation pattern for the bands. This is a rapid expansion of volatility. You will experience "fake out's" sometimes but most of the time this set-up will produce some good profits when executed properly.
4.) Price approaches the upper band and the upper and lower bands both go down. - Reversal - This is likely to result in a reversal but keep in mind price will likely only make it to the mean, the 21 period moving average with both bands heading down like this. This is a rare occurrence and is typical of a bigger market swing. A transition from Bullish to Bearish conditions.
Your best bet is to pull up 10 charts and spend some time observing how the bands react to approaching price action. My guess is when your done you'll likely take Bollinger bands out on her long overdue second date.
Mark Deaton
