How to Trade the Bollinger Band Squeeze | Best Trading Strategy

Day trading is a little tricky. Traders face hard times in trying to balance early spotting of entry points and the management of risk. Probably, there are fewer challenges in the market than volatility, which means huge volatility can mean very fast price movements. Low volatility, on the other hand, comes with stagnation frustration. A trader who enters the market without knowing how the market feels from a volatility perspective will incur unnecessary losses.

By becoming proficient in the Bollinger Band Squeeze, the trader will have enhanced preparation for market movements and enhanced entry and exit points. This article will take you through how the Bollinger Band Squeeze Indicator works, how to use it effectively, and an added twist—trading in the opposite direction for better results in specific market conditions.

What is the Bollinger Band Squeeze?

The Bollinger Bands are composed of three parts:

• Upper Band: Usually two standard deviations above a simple moving average, or SMA.
• Lower Band: Usually two standard deviations below the same SMA.
• Middle Line: This is the moving average itself. Often, it’s a 20-period SMA.

In principle, Bollinger Bands were supposed to be catching periods of high and low volatility. When the price is near the upper band, the market is likely overbought; near the lower band, it might be oversold. The squeeze occurs when the bands start tightening up around the price; hence, low volatility would signpost a significant future price movement.

How to Identify a Bollinger Band Squeeze

A Bollinger Band Squeeze is easy to see: the upper and lower bands converge toward one another, meaning the price range is quite tight. It’s a sign that the market is low in volatility, and this is the place where it will go on to break out one way or the other.

Some of the primary signs to watch for a squeeze are as follows:

• Thin Bands: The space between the upper band and the lower band decreases significantly.
• Price in the Middle: Squeeze tends to consolidate in the middle of the bands.
• Breakout Awaits: The first significant candle that breaks out beyond the bands marks the beginning of a breakout. This may be a bull or a bear breakout based on overall market conditions.

How to Trade the Bollinger Band Squeeze

After identifying a Bollinger Band Squeeze, you should next figure out how to trade it. Here is how to do it in a standard approach:

1. Wait for the BreakoutThe best entry time to a trade is when the price breaks above the upper band or below the lower band, after the squeeze. This breakout in the direction of the move is a sign of a high tendency towards volatility, which may probably translate to strong price momentum in the direction of the breakout.
   • Bullish Breakout: If the price breaks above the upper band with a large green candle, that might be an upward trend.
   • Bearish Breakout: If the price breaks through below the lower band with a strong red candle, you can expect a downward price movement.
2. Confirmation with VolumeVolume is an important component in confirming breakouts. Generally, less volume in a breakout does not hold its momentum. If you see a squeeze followed by a strong breakout with rising volume, then the probabilities are heightened for a sustained price move.
3. Use Stop-Loss OrdersWith any breakout strategy, there is a need to control the risk. Place a stop-loss order just inside the bands—on the opposite side of the breakout. This saves you from false breakouts, whereby the price moves briefly outside the bands before reversing back.

Trading the Opposite Direction

While the basic Bollinger Band Squeeze strategy fits many traders, here is the hitch: it’s obvious. In fact, many traders execute this very strategy, and thus the market surprisingly does the opposite, targeting amateur traders for surprise punches. What if you did the opposite of what most traders did?

Contrarian Strategy: Trade Against the Breakout

Sometimes, experienced traders will trade in the opposite side of the breakout, especially when the breakout is too obvious. Here’s why it works:

• False Breakouts: Most breakouts are not able to sustain their momentum. After an initial breakout, the market tends to reverse due either to profit taking by traders or because bigger players are pushing the market back to test previous levels.
• Volatility Swings: The market could become overly aggressive and overextended for some period after a squeeze, opening a reversal trading opportunity.

How to Use This Trade

1. Identify the Squeeze: Look for the bands to start contracting.
2. Wait for Breakout: However, do not bet right there in the direction of the breakout.
3. Watch for Reversal Signals: It may manifest as some candlestick patterns, such as the engulfing bars or hammer formations.
4. Enter the Trade: Enter a trade in the direction opposite to the breakout. Add indicators, such as RSI, showing overbought or oversold conditions, and an indication of possible reversal.
5. Place Your Stop-Loss: Locate the stop-loss right on the other side of the breakout to avoid losing while the breakout continues.

Adding a Timing Indicator

It’s well known that any contrarian approach needs good timing. To make the Bollinger Band Squeeze even more effective, you can use a timing indicator—15-period exponential moving average (EMA). This will allow you to enter the market at a much better time because an EMA follows the price action closer than the standard moving average does.

Why 15 EMA?

• More sensitive than the Bollinger Bands: The 15 EMA would generate an entry signal much earlier than the middle line of Bollinger Bands that is usually the 20-period SMA.
• Crossing Signal: If there was a squeeze at the crossing above or below the price to the 15 EMA, this could potentially be a sign to act.

For more accurate timing, some traders use a cycle indicator which will identify the highs and the lows of the market. This will make a confirmation about whether the breakout will continue or turn around, hence enabling more effective contrarian trades.

Conclusion

This is such a powerful tool in detecting potential market breakouts. However, if you are going to make a truly successful approach with this strategy, you have to know more than the basics. You must take into account the volume and use additional timing indicators, like a 15 EMA, to trade in the opposite direction when the market calls for it.

Whether you play it by the book or look to exploit contrarian sense, the keys to long-term success are practice and risk management. Improve on your approach as market conditions dictate and find that the Bollinger Band Squeeze truly is an invaluable addition to your trading arsenal.