Bollinger Band Bounces Strategy
The Bollinger Band bounce strategy relies on price rebounding inside a narrow range. Just because price moves within a defined range does not mean there are no trading opportunities.
Traders tend to prefer trading in a clear trend. When price sits in a defined range or appears to move sideways, many traders avoid trading a range-bound market altogether and stand aside until price takes a clear direction again. Even so, there are strategies for handling this more restricted price movement, and the Bollinger Band bounce strategy is one of the strategies used to trade within such a range.
The Bollinger Band Bounce Strategy and the Ranging Market
The Bollinger Band bounce strategy relies on an observable behavior of price: the Bollinger Bands act as a kind of limit on short-term price movement. The bands are well named in this respect, since they almost show the elastic properties of rubber bands. Price approaches the outer band, meets resistance, and bounces back in the opposite direction.
One way to take advantage of this behavior is to trade the bounces off the outer bands. This is not very effective in a one-directional (trending) market, but when the market is range-bound it can work well over short time frames.
The first thing to do when considering the Bollinger Band bounce strategy is to confirm that price is genuinely in a defined range. There are several ways to do this, but with Bollinger Bands I find the easiest is to check whether price stays on one side or the other of the middle band. If it does and price is consistently printing lower lows, price is heading down. The opposite of course applies to an uptrend: if price stays above the middle band and consistently prints higher highs, we are in an uptrend.
The following illustration shows price in a downtrend on the left of the screen turning into a market ranging within a defined range on the right:
The signal of a possible shift from a down-trending market to a ranging market appears at the bottom of the chart: a tweezer bottom candlestick pattern has formed. If this coincides with other factors such as support and resistance, a round number, a central pivot level, or a Fibonacci retracement level, the signal is stronger.
It might have been possible to enter at this level, though personally I prefer to wait to confirm that price is actually ranging in the opposite direction. That is what we see in the second illustration, with three possible entry points circled:
The Bollinger Band Bounce Strategy and Confirmation Signals
The confirming signals in the first two cases are a clear bearish candlestick pattern followed by a bullish engulfing pattern. The third entry was confirmed by an evening star, which is ideal.
Now we come to the mechanics of entry, stop loss, and taking profit. It is important to understand that this is essentially a forex trading strategy. The idea is to enter immediately once the signal is confirmed in the forex market, with a tight stop loss and profit taken at the opposite Bollinger band.
Once the move is confirmed by price, you should move the stop loss to breakeven as soon as possible. If you don’t, you can easily be caught out by price bouncing off the middle Bollinger band and the move reversing to stop out your trade. This would likely have happened on the first trade had you not moved immediately to breakeven when it was safe to do so.
Of course you will have to use your own judgment as to exactly when it is safe to move to breakeven: do it too early and you will be stopped out by normal bounces even if price is moving in the direction you want.
As a final note, this particular Bollinger Band bounce strategy is best traded in a very quiet market, with no imminent fundamental news announcements, on a pair that is not given to high price movement. It goes without saying that you should not enter trades based only on the fact that price has reached an outer band; look for other points of confluence.
The confirming factors that may support entry points include:
- Support and resistance levels
- Fibonacci pivot
- Round numbers
- Fibonacci levels
- Candlestick patterns
- Forex market direction
Finally, most charting applications for forex assets use Bollinger Bands with a 20-period moving average as the default settings. The upper and lower bands represent a measure of volatility to the upside and downside and are calculated as two standard deviations from the middle band.
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