If you live under a rock you may not know who John Bollinger is.
For the rest of us, we recognize him for being the innovator behind the technical indicator, Bollinger Bands, which has been around since 2001.
No matter the time frame, style of trading, or markets being analyzed…
Bollinger Bands can tackle the toughest jobs with ease!
Regardless If you are new to trading or a savvy vet— you are going to lose money at some point.
As traders we rely on tools to help us make better, faster, and more informed decisions.
There are thousands of technical indicators you can select from. However, there are only a handful that can help you predict future stock prices.
This is where Bollinger Bands really stand out from the rest.
They are truly unbelievable.
Don’t believe me just yet?
Give me less than five minutes…and I bet I can change your mind… not only turn you into a fan but even a practitioner.
Bollinger Bands are a bit of a mixed bag around here.
Many traders swear it is the key to their success while others avoid it like the plague.
This article is aimed to help beginning and experienced traders learn a highly effective strategy they can use immediately!
The beauty about this indicator is that it encapsulates the price movement of a stock.
Meaning, it provides relative high and low boundaries the stock should move inside.
The Bollinger Bands are based on the 20-period standard moving average and the upper and lower bands are a measure of volatility.
How they are calculated:
Middle Band = 20 period moving average
Upper Band = Middle Band + 2 standard deviations
Lower Band = Middle Band – 2 standard deviations
Here is a standard 20 period Bollinger Band plotted on the SPY’s:
The Bollinger Band can help you:
It’s important to remember…
When price is near the top of the Bollinger Band its “expensive” because it’s 2 standard deviations above its 20 period average.
And when the price is near the bottom of the bollinger band its “cheap” because its 2 standard deviations below its 20 period average.
Here’s an example:
I must warn you…
Don’t just buy whenever it’s cheap and sell whenever it’s expensive.
You will be buying (or selling) into momentum breakouts and will end up stepping in front of that train you have been warned about before.
That means don’t start going long when price reaches the lower bands.
… or this may happen to you.
You definitely don’t want to be selling into that type of momentum.
So what do you do?
If you want to have a high probability of success, you need a few confluence factors coming together before you trade the bands.
Now that the basics are covered, let’s get into details on how to turn the Bollinger Bands into a trading system.
… I mean that’s why we are all here today, right?
Bollinger bands are an extremely versatile indicator used by many traders around the globe and is built into almost every trading application on the market.
This indicator is used to help traders time the market and find optimal entry and exit prices on their trades.
Many traders even combine Bollinger Bands with their favorite patterns, such as double tops and double bottoms.
Some of the most common reversal strategies are :
Bollinger Band Double Touch Pattern
A Bollinger Band Double Touch pattern always starts with a double bottom or double top in the stock chart.
“Bollinger Bands can be used in pattern recognition to define/clarify pure price patterns such as “M” tops and “W” bottoms, changes in momentum, and short term reversons.”
– John Bollinger
This pattern sets up in 2 steps.
Many Bollinger Band technicians look for a retest bar to print inside the lower band.
This indicates that the downward pressures in the stock have subsided and the buyers are now in control.
Pro Tip: Sometimes you can skip on # 3 but be careful that Bollinger Bands are not indicating potential momentum to the downside.
In the above chart, you can identify the 3 main points to look for in the reversal pattern.
Let’s step through what played out in this trade.
Those three points have indicated both the technical support zone and the Bollinger Band support zone aligned.
Once this happened the next bar traded back inside the Bollinger Bands indicating the bulls were back in control and a long trade was safe to take landed over a 10% gains in that trade.
This strategy is for traders who like to trade scalpy and quick movements in a stock… (and yes, all these strategies apply to ANY timeframes you like to trade with little tweaking.)
Now that we covered the Snap Back pattern using Bollinger Bands, let’s take a look to apply the same techniques to a similar pattern.
The theory behind this strategy is that we are waiting for the markets to bounce off the bands and head back towards the middle moving average.
Remember, if a stock trades at the bands, its extended well past its average and theoretically should revert back to the average.
The beauty about this simple strategy is that it identifies clear entry and exit levels, leaving the trader to do what he does best. Just trade.
Let’s take a look at what I mean exactly.
In this example above there are two trades that set up. There was one long and one short trade on the SPY’s.
Pro Tip: A Stop And Reverse trading style for this strategy is a great way to boost even more profits.
This strategy is not a huge home-run hitter, but instead a singles and doubles approach to trading.
This requires a dedicated, rinse-and-repeat mentality, but it produces some of the most wildly profitable and consistent systems out there.
By not asking for much, you can safely pull money out of the market like an ATM on a consistent basis.
The key here is waiting for the Bollinger Bands to be broken. Jumping early into a trade can turn out to be a costly mistake if the Bollinger Bands don’t act as support or resistance.
Another simple and effective trading method is to look for a trade fading stocks after the move beyond the bands.
Let’s take a look at an example SPY trade using the hourly chart.
In the image above, you can easily notice a similarity between the two gaps.
The common element is that the price fades back to the opposite direction!
For example, instead of buying a stock that gaps below its lower band, wait to see how that stock performs. This same approach goes for taking a short position as well.
If a stock gaps below its lower band, it is best to wait to see if the stock can show signals of strength before going long.
Likewise, if the stock gaps up and closes near its highs, it’s best to wait for weakness to be seen.
In the above example:
For the long:
For the short:
This article covered three basic mean reversion strategies that are based on Bollinger Bands.
3 of the most common reversal strategies are :
Bollinger bands are an extremely versatile indicator used by many professional traders that helps to find the optimal entry and exit prices on their trades.
What you learned:
There are hundreds, possibly thousands of technical indicators that traders use to try to decipher trend, volume, and momentum.
But I’ll be perfectly honest with you.
Most of them just spit out noise—and do more harm than good.
But not all of them.
In fact, I’m going to teach you about gaps, and:
A gap is an area where the price of a stock moves sharply up or down.
Gaps occur because of fundamental or technical factors that are influencing the stocks.
They are typically found around periods of news or earnings that drive the price away from where it closed the day prior.
For example: If a company’s earnings are much higher than expected, the company’s stock may gap up the next day.
For day traders, a gap is a highly anticipated momentum signal.
Every day these traders have the same focus.
Find the biggest gappers, search for a catalyst, add to a chart in your grid, and execute trades when momentum picks up.
There are 6 fairly common types of gaps that can occur in a stock chart, with each having wildly different outcomes from one another.
Get your analysis incorrect, and you could be placing yourself on the wrong side of the markets with very little time to exit the trade.
Gaps can be classified into 6 groups:
Breakaway gaps are typically found at the very end of a price pattern and are typically seen as a shock to traders.
These gaps are typically found when a pattern is coming to a conclusion and buyers (or sellers) stepped in and started the next trend cycle.
In this example, the major triangle pattern is finally being invalidated by traders and a new direction is being declared.
Continuation gaps are also known as runaway gaps.
These gaps occur in an already existing pattern signaling a rush of buyers (or sellers) who believe the stock is continuing the current trend.
This is typically fundamentally driven and has outside influences other than technical trading patterns.
It is usually assumed that cash inflows are being rushed into the stock from major investment banks or institutions trying to get on the bandwagon.
Exhaustion gaps are typically found at the very end of a price pattern when buyers (or sellers) are stepping in to attempt starting a new trend.
These gaps are usually a final attempt by the controlling side to force the stock to new highs or lows and cause traders to exit their positions.
Exhaustion gaps by definition are almost always found at stocks highs and lows and are difficult to navigate since they are only noticed in hindsight.
Traders regularly confuse exhaustion gaps with continuation gaps while looking at stocks.
This confusion is because the gap tends to support a viewpoint from the trader and helps confirm a market reversal at the top or bottom of a trend.
These are also called “everyday gaps” because they occur every day.
This is due to overnight chatter, news, and stocks settling out in the closing rotations.
The common gaps don’t typically tell much of a story and are difficult to gain any insight from.
Pattern gaps are usually extremely volatile and sporadic in nature.
They tend to form at or near market tops or bottoms due to the active fighting for direction between the buyers and sellers.
Pattern gaps are sometimes also called Common gaps, and tend to be larger in size.
I always recommend to stay away from pattern gaps as there is no trend or direction chosen and it is extremely easy to be caught on the wrong side of the markets.
Merger and Acquisition gaps occur around news and other corporate takeover events.
These gaps are typically generated from buyout rumors, buyout deals, and FOMO trading from retail investors since all major news outlets are publishing headlines on this stock.
Here is an example of TD Ameritrade that gapped higher based on M&A news overnight.
As expected, there was immediate selling in the stock as traders took profits and sellers stepped in to drive the stock lower.
Now that each gap is identified, let’s take a look at two different ways you can trade the gap.
Each trader has their own idea of why a gap was formed and which direction it should take.
Every gap tells its own story and therefore bears a different meaning to each trader who analyzes it.
There are two categories that you can trade a gap.
Gap continuation is a trade that continues in the direction of the gap.
Usually gaps will continue their trend only when its a healthy market and the primarily buyers (or sellers) want to remain in control.
Breakaway gaps and Continuation gaps are typically the only two gap patterns that will have continuation in their price action.
Pro Tip: institutions and large hedge funds will tend to pile into stocks when there is a healthy trend causing these gaps to occur or continue.
Gap Fading is a trade that reverses the direction of the gap.
This usually occurs when a trend is becoming exhausted and stall out.
Gap fades are typically seen at the top or bottom of of trends and the opposite direction is about to begin.
Exhaustion gaps and M&A gaps are typically the only gaps that tend to fade.
Is it common for gaps to be filled? Yes and no.
Depending on the type of gap and the strength of the move, it’s possible for a gap to be filled.
Both of those factors will determine if the gap can be filled that same day or if it will require more time.
The speed at which a gap is filled usually depends on the ‘shock’ the gap produced in the chart.
Pro Tip: Some gaps are so strong can destroy technical patterns and invalidate setups.
It’s important to remember that gaps are caused by emotion.
Due to human emotions there are many different factors that impact a stock.
It’s always hard to know if a stock will fade from the open or just continue in the new direction.
When a gap is filled it usually boils down to a handful of reasons.
Gaps are filled from 3 major reasons:
When the initial spike in price may have been overly optimistic from FOMO traders getting into the breaking news.
They are exiting the trades with either a quick profit or after they have realized they made the wrong decision.
Common when a price moves up sharply.
If a stock gaps up into technical resistance, it has a higher probability of reversing and filling the gap to the downside. Some examples of technical resistance are trendlines, technical patterns, support and resistance zones, 52-week high and lows, etc.
Important since it gives the trader the “bigger picture” as to what the stock should be doing.
Price patterns are typically used to identify exhaustion and continuation gaps.
Wait a minute…
Before rushing off to “Gaple-Bees” and placing your new found trades, you must remember that not all gaps are created equally.
Some gaps are useful for day trading with other gaps that are great for determining major swings in the markets.
But did you know I can frequently use these tools to analyze gaps that help daily trading the SPY instead of specific stocks?
With a quick and simple gap analysis it’s possible to know exactly which way the market is going in the following few days.
Keep your eyes peeled for the next article on using gap analysis to trade the SPY’s!
Did you know that most traders lose money when trading candlestick patterns?
Why? Because everyone trades them the same way!
It was not long ago I was making the same mistakes. Getting into trades far too early just to watch my stops get hit.
So that’s when I sat down and thought about how I can put the odds in my favor.
I began tweaking the way I interpreted candlesticks, and let me tell you, its been a game changer for me.
Not only do candlesticks work, I’ve found a specific pattern, that wins nearly all the time.
And you know what else?
This pattern could signal a huge sell-off in the SPY… and it could happen sooner than a lot of traders expect.
In order to identify a Bearish Engulfing Pattern, try to imagine a mountain with its snowy top and steep sides.
Where prices are rising upwards on the one side of the mountain and downward on the other and the engulfing pattern is the snow-covered top.
The top of the mountain is made up of a pattern that is formed by two candles and typically identified with a green candle followed by a red candle.
It gets its name by the strong price action being engulfed by the weak price.
More specifically, the green candle is being engulfed by the red candle.
What does a Bearish Engulfing Pattern indicate?
How to recognize it:
This signals that sellers have completely overwhelmed the buyers and are now in control of the stock price.
Great – so let’s get trading!
Unfortunately, there are literally thousands of signals going off.
Here is an example of all of the Bearish Engulfing Patterns on the QQQ’s.
As we can see by the chart, there are too many trades to take blindly.
It’s best to combine multiple patterns to help identify a true market reversal.
It’s always important to combine tools when trying to place a short trade in the markets.
One tool that I use in my daily analysis is identifying resistance zones.
The closer a stock can get to resistance the more likely it is to have a sell-off.
In this example, the SPY was bumping up against resistance at the same time a Bearish Engulfing Pattern emerged.
What a perfect setup – giving about 3% of profits in the SPYs in just a few days!
Here is another example of the SPY’s selling off after a Bearish Engulfing Pattern as the price touched a Fibonacci Extension level.
Another great setup!
The SPY’s signaled to me that the bears were in control at the high’s near $292.
The sellers were successfully able to drive the price down to $272 or about 7% lower!
Pro Tip: This works really well in strong trending or parabolic markets.
It’s important to make sure there is strong price action at the resistance level.
When you are trading the Bearish Engulfing Pattern, you don’t want to see weak price action at a key level.
Why is that?
It’s not a strong conviction that sellers are in control and you may be selling into the uptrend.
Weak price action:
In this example above, you can see how the rejection was weak and the sellers were not in control.
Instead, you want a strong price rejection.
So strong that the Bearish Engulfing pattern exceeds multiple candles.
Strong Price Action:
See the difference?
It’s important that you monitor the price rejection at key levels.
With such higher price action the market is more likely to reverse lower.
Nobody is a fortune teller but we can anticipate future stock prices by using the tools we have as a trader…
As shown previously, it appears that Bearish Engulfing Patterns work well around areas of resistance either in past trading or using Fibonacci Extensions.
What if we are looking to get short the markets and want to anticipate a Bearish Engulfing Pattern?
Here is the current SPY and how we can use these similar tools to anticipate market direction.
As you can see, the SPY is still a bit away from the Fibonacci resistance level.
And that’s perfect!
Now we wait for the Bearish Engulfing Pattern to emerge, hopefully right near the Fibonacci level. It must also have large price action.
That would make for the perfect storm. But only time will tell now.
That’s right, 90% of the last Bearish Engulfing Patterns were spot on!
That’s a 90% win rate if you followed a simple candlestick pattern like this!
So stop missing out on trades like these!