Most traders have no idea when to enter or exit the trade; this is how one gets caught in extended price movements that lead to losses. Old ways of price action analysis at times prove misleading, leaving one unsure whether prices will continue moving in the direction they are moving or not. In a very noisy market, what one needs is a strategy founded on statistical evidence rather than subjective theories to help make the right decision.
The Bollinger Bands tool is one of the most dependable instruments in overcoming such challenges. Developed by John Bollinger, this tool measures market volatility and provides insights into price trends. Still, many traders do not avail themselves of its full potential. With the Bollinger Bands tool, scalpers can quickly make trades that have high chances, as they are based on statistical analysis rather than guesses.
This article will introduce one of the most powerful Bollinger Bands trading strategies that has recently emerged as a scalping strategy, based on proper statistical analysis. We will discuss the mechanism behind this strategy, the concept of supply and demand, and learn how to apply it in practice for maximum gain.
What Are Bollinger Bands?
Bollinger Bands make up a triad of three lines:
- Upper Band: Generally two standard deviations above a 20-period simple moving average (SMA).
- Lower Band: Generally two standard deviations below the same SMA.
- Mid Band: The 20-period SMA itself, a measure of the mean.
The concept of Bollinger Bands is meant to represent volatility and potential price reversals. When prices pierce through these bands, it indicates an extreme market condition that statistically would not last too long, providing the trader with a great trading opportunity.
The New Bollinger Bands Trading Strategy
Setup: Identifying Overextended Price Movements
The core of this trading strategy is spotting price bars that closed entirely above the upper Bollinger Band or completely below the lower one. Why?
- Statistical Rarity: When prices breakout beyond two standard deviations, there is a good chance that such a move will not be sustainable. Statistically speaking, the chance of prices continuing along that path is extremely low—usually around 2.5% for moves beyond two standard deviations.
- High Probability: Trading back to the mean, or the 20-period SMA, from these extreme conditions provides a high probability trading opportunity.
Bollinger Band Settings
This strategy requires you to set the Bollinger Bands to a 20-period SMA, with the standard deviation set at two. With these settings, you will obtain a clearer view of when the market is in its extreme conditions.
Waiting for the Trigger
Once the setup is established, wait for the trigger, which usually turns into a price structure reversal. Here’s how to approach it:
- Be on the Lookout for Reversal Patterns: Look for candlestick formations like shooting stars or engulfing patterns that signal a reversal.
- Shift in Supply and Demand: Understand that prices increase whenever demand grows more than supply and vice versa. Wait for the actual occurrence of this shift to ensure the price would likely revert back towards the mean.
Euro and Apple Stocks
Use two examples: one for the Euro and one for Apple stocks.
- Euro Example: If the price has surged into the extreme, expecting to close above the upper Bollinger Band, wait for a reversal pattern and evidence of a supply move. Once confirmed, enter the trade short and expect to move back to the mean.
- Apple Example: Similarly, if Apple stock is likely going to close below the lower band, apply the same rules. Confirm entry with reversal patterns and supply shifts.
Using a Market Timing Indicator
You can use a market timing indicator to make even finer entries and exits. This indicator provides objective signals for entering trades, relying on mathematical calculations and avoiding subjectivity.
- Consistency: A market timing indicator offers consistency in identifying setups and triggers, enabling you to trade with confidence.
- Free Access: Many traders provide modified versions of commonly used indicators for market timing, often available for free through webinars and tutorials.
Risk Management: Protect Your Capital
The Bollinger Bands trading strategy is statistically sound, but you need to integrate appropriate risk management techniques, such as:
- Stop-Loss Orders: Always use stop-loss orders just outside the Bollinger Bands to guard against false breakouts.
- Take Profit Levels: Aim to take profits when the price reaches the mean to capitalize on the reversal without being greedy.
Conclusion
The scalping strategy using Bollinger Bands provides a robust framework for identifying high-probability trades based on statistical principles. Specifically, we focus on price movements beyond two standard deviations and shifts in supply and demand.
To implement this strategy:
- Set your Bollinger Bands to a 20-period SMA.
- Monitor for reversals in market conditions.
- Complement your strategy with market timing indicators for better trading decisions.
- Maintain discipline in risk management.
Applying this new trading strategy with Bollinger Bands will enable traders to navigate markets more effectively, thus increasing the chances of success and converting statistical analysis into profit.
