When John Bollinger introduced the Bollinger Bands strategy over 20 years ago, I was skeptical about its longevity.
That’s because I’ve seen countless fad trading strategies come and go over the years…
What typically happens is a trading strategy works well for specific market conditions and becomes extremely popular. But once those conditions change, the strategy no longer works and it’s quickly replaced by the next big thing.
I thought the Bollinger Bands strategy would last a short time and fade into the sunset like most popular trading strategies of the time.
But I have to admit, I was wrong…
Bollinger Bands have become one of the most reliable technical indicators ever created.
What Is the Bollinger Bands Strategy?
Bollinger Bands is a rather simple indicator…
It begins with the 20-day simple moving average of the closing prices.
The upper and lower bands are then set two standard deviations above and below this moving average (MA). The bands move away from the MA when volatility expands, and move toward the MA when volatility contracts.
The length of the MA depends on the time frame each trader uses.
For today’s example, we’ll rely on the standard settings to keep things simple.
Notice in the example below how the bands expand and contract depending on the volatility and trading range of the market.
The bands dynamically narrow and widen based on the day to day price action changes.
The Bollinger Band Width
There’s one additional indicator that works hand in hand with the Bollinger Bands strategy that many traders don’t know about…
It’s actually part of the strategy, but because the bands are always drawn on the chart instead of below it, there’s no logical place to put this indicator.
The indicator is called the “Band Width.”
The sole purpose of this indicator is to subtract the lower band’s value from the upper band.
Notice in this example how the Band Width indicator gives lower readings when the bands contract, and higher readings when bands expand.
1 Bollinger Bands Strategy That Has My Attention
I’ve used the Bollinger Bands strategy many different ways over the years with positive results.
But one particular strategy I use when volatility is falling is the Squeeze Entry strategy. It’s a simple strategy and works well for stocks, futures, foreign currencies and commodity contracts.
The Squeeze strategy is based on the idea that once volatility decreases for extended periods of time, the opposite reaction typically occurs, and volatility expands greatly once again.
When volatility expands, markets usually begin trending strongly in one direction for a short period of time.
The squeeze begins with the Band Width making a six-month low.
And it doesn’t matter what the actual number is because it’s relative only to the market you’re looking to trade… nothing else.
In this example, you can see IBM Common Stock (NYSE: IBM) reaching its lowest level of volatility in six months.
Notice how the price of IBM is barely moving at the time the six-month Band Width low is reached…
This is the time to begin looking at markets because six-month low Band Width levels typically precede strong directional moves.
In the example below, you can see how IBM breaks outside of the upper Bollinger Band immediately after the stock’s Band Width level reached a six-month low.
This is a common occurrence, and one you should watch out for on a daily basis. The six-month Band Width low is a great indicator that precedes strong directional momentum.
In another example below, you’ll notice how Apple Inc. (Nasdaq: AAPL) reached its lowest Band Width level in six months. And one day later, it broke outside of the upper band.
This is the type of setup you want to monitor on a daily basis when using the Band Width indicator and the Squeeze Entry strategy.
You’ll also notice how the Band Width begins to increase quickly after reaching the six-month low level.
The price of the stock usually begins moving higher within a few days of the six-month Band Width low.
Things to Keep in Mind
The Squeeze Entry strategy is one of the simplest and most effective methods for gauging market volatility, expansions and contractions.
But always remember that markets go through different cycles.
So once volatility decreases to a six-month low, a reversion tends to occur and volatility will go up once again.
When volatility begins to increase, prices usually begin moving in one direction for a short period of time.
For more pullback strategies, check out these previous articles:
- The Best Pullback Strategy for Beginner Traders: The 4×4 Strategy
- 1 Simple Pullback Strategy That Actually Works: The Tail Gap Strategy.
Wishing you the best,
Roger Scott
Senior Strategist, WealthPress
