How to use Bollinger Bands to find Stocks before big breakout runs. I promise I will make this as painless as possible, but it would be wrong of me not to give my newbies the "who created and what are" Bollinger Bands introduction. This evolving top formed a small head-and-shoulders pattern.
We need to have an edge when trading a bollinger band squeeze because these setups can head-fake the best of us. It immediately reversed, and all the breakout traders were head faked. You don't have to squeeze every penny out of a trade. Wait for some confirmation of the breakout and then go with it. If you are right, it will go much further in your direction. Notice how the price and volume broke when approaching the head fake highs yellow line. To the point of waiting for confirmation, let's look at how to use the power of a Bollinger Band squeeze to our advantage.
Notice how leading up to the morning gap the bands were extremely tight. Now some traders can take the elementary trading approach of shorting the stock on the open with the assumption that the amount of energy developed during the tightness of the bands will carry the stock much lower.
Another approach is to wait for confirmation of this belief. So, the way to handle this sort of setup is to 1 wait for the candlestick to come back inside of the bands and 2 make sure there are a few inside bars that do not break the low of the first bar and 3 short on the break of the low of the first candlestick.
Based on reading these three requirements you can imagine this does not happen very often in the market, but when it does, it's something else. The below chart depicts this approach. Now let's look at the same sort of setup but on the long side. Below is a snapshot of Google from April 26, Notice how GOOG gapped up over the upper band on the open, had a small retracement back inside of the bands, then later exceeded the high of the first candlestick.
These sorts of setups can prove powerful if they end up riding the bands. This strategy is for those of us that like to ask for very little from the markets. Essentially you are waiting for the market to bounce off the bands back to the middle line.
You are not obsessed with getting in a position and it wildly swinging in your favor. Nor are you looking to be a prophet of sorts and try to predict how far a stock should or should not run. By not asking for much, you will be able to safely pull money out of the market on a consistent basis and ultimately reduce the wild fluctuations of your account balance, which is common for traders that take big risks.
The key to this strategy is waiting on a test of the mid-line before entering the position. You can increase your likelihood of placing a winning trade if you go in the direction of the primary trend and there is a sizable amount of volatility.
As you can see in the above example, notice how the stock had a sharp run-up, only to pull back to the mid-line. You would want to enter the position after the failed attempt to break to the downside. You can then sell the position on a test of the upper band.
If you have an appetite for risk, you can ride the bands to determine where to exit the position. This is honestly my favorite of the strategies. If I gave you any other indication that I preferred one of the other signals, forget whatever I said earlier. First, you need to find a stock that is stuck in a trading range. The greater the range, the better. Now, looking at this chart, I feel a sense of boredom coming over me. However, from my experience, the guys that take money out of the market when it presents itself, are the ones sitting with a big pile of cash at the end of the day.
In the above example, you just buy when a stock tests the low end of its range and the lower band. Conversely, you sell when the stock tests the high of the range and the upper band. The key to this strategy is a stock having a clearly defined trading range.
This way you are not trading the bands blindly but are using the bands to gauge when a stock has gone too far. You could argue that you don't need the bands to execute this strategy.
However, by having the bands, you can validate that a security is in a flat or low volatility phase, by reviewing the look and feel of the bands. So, instead of trying to win big, you just play the range and collect all your pennies on each price swing of the stock. Like anything else in the market, there are no guarantees. Bollinger Bands can be a great tool for identifying volatility in a security, but it can also prove to be a nightmare when it comes to newbie traders.
Don't skip ahead, but I will touch on this from my personal experience a little later in this article. Not exiting your trade can almost prove disastrous as three of the aforementioned strategies are trying to capture the benefits of a volatility spike.
For example, imagine you are short a stock that reverses back to the highs and begins riding the bands. What would you do? While bands do a great job of encapsulating price movement, it only takes one extremely volatile stock to show you the bands are nothing more than man's failed attempt to control the uncontrollable. While there is still more content for you to consume, please remember one thing - you must have stopped in place!
Let me help you out if you are confused - kill the trade! While bandsdo a great job of encapsulating price movement, it only takes one extremely volatile stock to show you the bands are nothing more than man's failed attempt to control the uncontrollable. Strategy 5 - Snap back to mthe iddle band, will work in very strong markets.
I have been a breakout trader for years and let me tell you that most breakouts fail. Not to say pullbacks are without their own issues, but you at least minimize your risk by not buying at the top. Shifting gears to strategy 6 - Trade Inside the Bands, this approach will work well in sideways markets. Because you are not asking much from the market in terms of price movement.
From my personal experience of placing thousands of trades, the more profit you search for in the market, the less likely you will be right. Don't worry, I'm not about to go on a history lesson on cryptocurrencies with details of where David Chaum went to college. I was reading an article on Forbes, and it highlighted 6 volatile swings of bitcoin starting from November through March So, I wanted to do my own research and I looked at the most recent price swings of Bitcoin in the Tradingsim platform.
Let's look at the period of December 22, ,to December 27, During this period, Bitcoin ran from a low of 12, to a high of 16, Let's unpack this a little further. Do you realize that these gains were largely made over 3 days' worth of trading? I am getting a little older now and hopefully a little wiser and that kind of money that fast, I have learned is almost impossible for me to grasp. The psychological warfare of the highs and the lows become unmanageable.
So, it got me thinking, would applying bands to a chart of bitcoin futures have helped with making the right trade? I indicated on the chart where bitcoin closed outside of the bands as a possible turning point for both the rally and the selloff.
But let's be honest here, this is a minute chart of a highly volatile security. You must honestly ask yourself will you have the discipline to make split second decisions to time this trade, just right? The one thing the bands manages to do as promised is contain the price action, even on something as wild as bitcoin. I honestly find it hard to determine when bitcoin is going to take a turn looking at the bands.
It's not that the bands are doing anything wrong or not working. Bitcoin is just illustrating the harsh reality when trading volatile cryptocurrencies that there is no room for error. I personally do not trade bitcoin, but after looking at the most recent price swing using bands a couple of things come to mind:. Pairing the Bollinger Band width indicator with Bollinger Bands is like combining the perfect red wine and meat combo you can find. In the previous section, we talked about staying away from changing the settings.
Well, if you really think about it, your entire reasoning for changing the settings in the first place is in hopes of identifying how a security is likely to move based on its volatility. I thought it would last a short time and would fade into the sunset like most popular trading strategies of the time.
I have to admit that I was wrong and Bollinger Bands became one of the most relied on technical indicators that was ever created. The upper and lower bands are then set two standard deviations above and below this moving average. The bands move away from the moving average when volatility expands and move towards the moving average when volatility contracts. Many traders length of the moving average depending on the time frame they use.
Notice in this example how the bands expand and contract depending on the volatility and the trading range of the market. Notice how the bands dynamically narrow and widen based on the day to day price action changes.
The indicator is called Band-Width and the sole purpose of this indicator is to subtract the lower band value from the upper band. Notice in this example how the Band-Width indicator gives lower readings when the bands are contracting and higher readings when bands are expanding. First, a reaction low forms. This low is usually, but not always, below the lower band.
Second, there is a bounce towards the middle band. Third, there is a new price low in the security. This low holds above the lower band. The ability to hold above the lower band on the test shows less weakness on the last decline. Fourth, the pattern is confirmed with a strong move off the second low and a resistance break. First, the stock formed a reaction low in January black arrow and broke below the lower band.
Second, there was a bounce back above the middle band. Third, the stock moved below its January low and held above the lower band. Even though the 5-Feb spike low broke the lower band, Bollinger Bands are calculated using closing prices so signals should also be based on closing prices.
Fourth, the stock surged with expanding volume in late February and broke above the early February high. M-Tops were also part of Arthur Merrill's work that identified 16 patterns with a basic M shape. According to Bollinger, tops are usually more complicated and drawn out than bottoms. Double tops, head-and-shoulders patterns, and diamonds represent evolving tops.
In its most basic form, an M-Top is similar to a double top. However, the reaction highs are not always equal. The first high can be higher or lower than the second high. Bollinger suggests looking for signs of non-confirmation when a security is making new highs. This is basically the opposite of the W-Bottom.
A non-confirmation occurs with three steps. First, a security creates a reaction high above the upper band. Second, there is a pullback towards the middle band.
Third, prices move above the prior high but fail to reach the upper band. This is a warning sign. The inability of the second reaction high to reach the upper band shows waning momentum, which can foreshadow a trend reversal. Final confirmation comes with a support break or bearish indicator signal. The stock moved above the upper band in April. There was a pullback in May and then another push above Even though the stock moved above the upper band on an intraday basis, it did not CLOSE above the upper band.
The M-Top was confirmed with a support break two weeks later. Also, notice that MACD formed a bearish divergence and moved below its signal line for confirmation. Price exceeded the upper band in early September to affirm the uptrend. After a pullback below the day SMA middle Bollinger Band , the stock moved to a higher high above Despite this new high for the move, price did not exceed the upper band.
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