Bollinger Bands is a trading tool developed by John Bollinger in the early 1980. The use of Bollinger Band in Equity market has been so intensive, which makes us think that this indicator is one of the greatest indicators ever developed.
Bollinger Band consists of 3 elements:
a) A Simple Moving Average: Period used for this MA should coincide with your highest MA-period.
(For example: SMA 20 in VN-stock market and 55 for US)
b) Upper and Lower Band: These band by default are 2 standard deviation away from the SMA.
1) Signal correction in trending market.
Whenever price violates the upper band in an uptrend or the lower band in a downtrend, the price will have a tendency to correct to the middle SMA before the trend resumes.
On Vinamilk daily chart. Whenever Price goes out of the Bollinger Band ( orange cycles), it tend to come back in and give us a perfect opportunity to buy (point marked with blue arrows)
On GAS (VN market) daily chart, we see the price correct into the Bollinger Band if it violates the lower band(downtrend), which gives us opportunity to sell ( point marked with red arrows). As nothing works 100% of the time, the orange cycle marks a situation in the market where the crowd is panicking, which makes the selling pressure so strong. In the situation where oil prices drops dramatically like this, the fundamental might disregard all the technical indicators.
As mentioned in Moving Average section, we need to buy near a support. In a trending market, if price already breaks out of the Bollinger Band, we should patiently wait until the price correct into the SMA and buy/sell (in uptrend/downtrend). Executing trade “in the middle of nowhere” faces a very big risk of market correction so again, market only rewards those who are patient.
However, there are times you should ignore the fact that price is already outside the Bollinger Band. We will talk about in it in the next part.
2) The squeeze of Bollinger Band
When volatility is so low, 2 bands will squeeze toward the SMA. It is usually an indication of SUPER HIGH volatility coming. Trade should be executed (buy/sell) when Price breaks the highest/lowest point of the consolidation.
Let’s take a look at some examples:
Viettin Bank and Visa provide us with very nice Bollinger Band Squeeze setups. Price rallies unstoppably after the breakout- anyone catch this move might have a vacation for the rest of the year because it is so profitable. However there are always downsides of a strategy.
Let’s discuss the risk of this strategy. With experienced traders, they might tell which breakout is false but for new traders, this task would be impossible. There are times when price breaks the Bollinger Band just to come back into the consolidation the day after(as marked in CTG daily chart). There are some guidelines we think would help new traders recognize a legitimate breakout:
a) Price breakout due to a news release ( M&A or earning report)
b) Long candle close above the extreme point of the consolidation
The hardest part of trading “the squeeze of Bollinger Band” is that you don’t know when the price will break out. Sometimes it takes weeks, sometimes months or even years to complete the squeeze of Bollinger Band, which mean you will need to check out the price of that security 5 days a week for months. However, as you might see, the reward is always worth your patience! If you make a loss in a false breakout, just close the trade and wait. A legitimate breakout should compensate for 5 times the loss you made. Patience and courage are the key.