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Mar 18 00:05 GMT The Ultimate Trade Setup using Bollinger Bands Technical Analysis Articles | Written by Jim Robinson |
On 8/08/03 The Bollinger Bands moved extremely close together The trade setup stuck out like a sore thumb. There was no missing this one Beans exploded above the bands and the rest is history.
For those who are willing to take a non-mechanical approach trading head fakes, the easiest strategy is to wait until a Squeeze occurs--the precondition is set--then look for the first move away from the trading range. Trade half a position the first strong day in the opposite direction of the head fake, adding to the position when the breakout occurs and using a parabolic or opposite band tag stop to keep from being hurt.
The major problem with successfully implementing Method I is something called a head fake--discussed in the prior chapter. The term came from hockey, but it is familiar in many other arenas as well. The idea is a player with the puck skates up the ice toward an opponent. As he skates he turns his head in preparation to pass the defender; as soon as the defenseman commits, he turns his body the other way and safely snaps his shot. Coming out of a Squeeze, stocks often do the same; they'll first feint in the wrong direction and then make the real move. Typically what you'll see is a Squeeze, followed by a band tag, followed in turn by the real move. Most often this will occur within the bands and you won't get a breakout signal until after the real move is under way. However, if the parameters for the bands have been tightened, as so many who use this approach do, you may find yourself with the occasional small whipsaw before the real trade appears. Some stocks, indices, etc are more prone to head fakes than others. Take a look at past Squeezes for the item you are considering and see if they involved head fakes. Once a faker?
Where head fakes aren't a problem, or the band parameters aren't set tight enough for those that do occur to be a problem, you can trade Method I straight up. Just wait for a Squeeze and go with the first breakout.
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Here's what has happened since the above was written. Natural Gas has exploded to the upside. Notice how The Bollinger Bands went from narrow range (Low Volatility) and are expanding with the rally (High Volatility).

The reason it may take a couple trys to get in the market on the right side of the big trend move is because the market may make a false breakout. For example the market may make a base and be ready to make a strong rally but first may make a strong move below the base. This is called a false breakout or head fake. Then the real move may begin and the market will rally from there. The false breakout can be in either direction and sometimes there may be a couple of false moves.

Volume indicators can really add value. In the phase before the head fake look for a volume indicator such as Intraday Intensity or Accumulation Distribution to give a hint regarding the ultimate resolution. MFI is another indicator that can be useful to improve success and confidence. These are all volume indicators and are taken up in Part IV.

At the beginning of this chart from 3/20/03 to 5/06/03 Wheat made a narrow range base pattern. The Bollinger Bands narrowed down. There was no doubt that a low volatility move was happening. This put us on alert that this was a Million Dollar trade setup. A possible trading opportunity was at hand, Wheat exploded to the upside from there

#1 - A Major Low is most likely in - this market should continue to rally
#2 - Since the bands expanded as the market rallied
The trend should continue much higher from here
#3 - We can buy all corrections in this market from here
Perhaps the most elegant direct application of Bollinger Bands is a volatility breakout system. These systems have been around a long time and exist in many varieties and forms. The earliest breakout systems used simple averages of the highs and lows, often shifted up or down a bit. As time went on average true range was frequently a factor.

STOCKS

FROM JOHN BOLLINGER - ON BOLLINGER BANDS - [link widoczny dla zalogowanych]

There is one other parameter that can be set, the look-back period for the Squeeze. The longer you set the look-back period--recall that the default is six months--the greater the compression you'll achieve and the more explosive the set ups will be. However, there will be fewer of them. There is always a price to pay it seems.
Jim Robinson
[link widoczny dla zalogowanych]

The parameters for a volatility breakout system based on The Squeeze can be the standard parameters: 20-day average and +/- two standard deviation bands. This is true because in this phase of activity the bands are quite close together and thus the triggers are very close by. However, some short-term traders may want to shorten the average a bit, say to 15 periods and tighten the bands a bit, say to 1.5 standard deviations.

SOYBEANS - BLAST OFF!

CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
Our version of the venerable volatility breakout system utilizes BandWidth to set the precondition and then takes a position when a breakout occurs. There are two choices for a stop/exit for this approach. First,[link widoczny dla zalogowanych], Welles Wilder's Parabolic3,[link widoczny dla zalogowanych], a simple, but elegant, concept. In the case of a stop for a buy signal, the initial stop is set just below the range of the breakout formation and then incremented upward each day the trade is open. Just the opposite is true for a sell. For those willing to pursue larger profits than those afforded by the relatively conservative Parabolic approach, a tag of the opposite band is an excellent exit signal. This allows for corrections along the way and results in longer trades. So, in a buy use a tag of the lower band as an exit and in a sell use a tag of the upper band as an exit.

This gives us alot of trading information
The parabolic indicator is just one idea for an entry signal. You can use whatever entry signal works for you. When you see a low volatility market.
NATURAL GAS

Of Course we have to monitor the market on a daily basis. Any of this can change at any time. But as today the above market analysis is good. A low is in - stay bullish - look for places to buy. As always use a stop if wrong on all trades.

WHEAT - A NARROW RANGE BASE
So you use the parabolic to:
#1 - Enter the market
#2 - As a stop if wrong on the entry signal
#3 - As a new entry point to go with the market the other direction if need be

Here are some examples of stocks making a narrow range and then a strong move.
Look for your Method I setups carefully and then follow them as they evolve. There is something about looking at a large number of these setups, especially with volume indicators, that instructs the eye and thus informs the future selection process as no hard and fast rules ever can

The parabolic stop indicator is a great way to make sure you are on board for the big move and a good indicator to use as a stop. Sometimes it takes a couple of trys to get aboard the big move. The parabolic is a stop and reverse trading system. The parabolic will work excellent as an entry signal then use the parabolic stop and reverse signal to change positions in the market if need be
Markets move between low volatility trading range moves to high Volatility trend moves. One of the best ways to see this taking place is with the Bollinger Bands. When a market makes a extremely narrow range move, the Bollinger Bands will noticably narrow together. When the bands narrow down,[link widoczny dla zalogowanych], it shows an extremely low volatiltiy market. A low volatility market forecasts - a high volatility trend move is more than likely - just around the corner. This is a big trading setup and a money making opportunity is at hand. The Bands narrowing together does not forecast the direction that the breakout will be but often times it is fairly clear from classic technical analysis which way the odds favor the breakout to be.

THE ENTRY SIGNAL

Method I first detects compression through The Squeeze and then looks for range expansion to occur and goes with it. An awareness of head fakes and volume indicator confirmation can add significantly to the record of this approach. Screening a reasonable size universe of stocks--at least several hundred--ought to find at least several candidates to evaluate on any given day.
There is no real way of knowing when volatility, as we use it now, was incorporated as a factor, but one would surmise that one day someone noticed that breakout signals worked better when the averages, bands, envelopes, etc., were closer together and the volatility breakout system was born. (Certainly the risk-reward parameters are better aligned when the bands are narrow, a major factor in any system.)

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A FEW MORE CHARTS

Years ago the late Bruce Babcock of Commodity Traders Consumers Review interviewed me for that publication. After the interview we chatted for a while--the interviewing gradually reversed--and it came out that his favorite commodity trading approach was the volatility breakout. I could hardly believe my ears. Here is the fellow who had examined more trading systems--and done so rigorously--than anyone with the possible exception of John Hill of Futures Truth and he was saying that his approach of choice to trading was the volatility-breakout system? The very approach that I thought best for trading after a lot of investigation?
The below write up and chart was sent out to my newsletter subscribers. Before Natural Gas made the big move: This chart of Natural Gas is making a narrow range. We could start taking parabolic buy and sell signals until we caught the trend. Also we could wait for a breakout and look for the bands to expand. That would show us the direction of the breakout. Then we could hop aboard in the direction of the trend since Natural Gas has been in a downtrend and is making a base. Odds favor that this market will explode to the upside.

Disclaimer - I am not a stock or commodity trading advisor. The information on this site is for trading education only. There are no trading recommendations for any one individual made on this site and this information is paper trades for trading education. All trades are extemely risky and only risk capital should be used when trading.