Strategy – Bollinger Band Squeeze

Another bollinger bands trading strategy is to gauge the initiation of an upcoming squeeze.

John created an indicator known as the band width. This bollinger band width formula is simply (Upper Bollinger Band Value – Lower Bollinger Band Value) / Middle Bollinger Band Value (Simple moving average).

The idea, using daily charts, is that when the indicator reaches its lowest level in 6 months, you can expect the volatility to increase. This goes back to the tightening of the bands that I mentioned above. This squeezing action of the bollinger band indicator foreshadows a big move. You can use additional signs such as volume expanding, or the accumulation distribution indicator turning up.

These other indications add more evidence of a potential bollinger band squeeze.

We need to have an edge though when trading a bollinger band squeeze because these types of setups can head-fake the best of us.

Notice above in the BSC chart (#3 Strategy) how the bollinger price expanded on the opening of 9/26.

It immediately reversed, and all the breakout traders were head faked. You don’t have to squeeze every penny out of a trade. Wait for some confirmation of the breakout and then go with it. If you are right, it will go much further in your direction. Notice how the price and volume broke when approaching the head fake highs (yellow line).

To the point of waiting for confirmation, let’s take a look at how to use the power of a bollinger band squeeze to our advantage.  Below is a 5-minute chart of Research in Motion Limited (RIMM) from June 17, 2011.  Notice how leading up to the morning gap the bands were extremely tight.

Tight Bollinger Bands

Now some traders can take the elementary trading approach of shorting the stock on the open with the assumption that the amount of energy developed during the tightness of the bands will carry the stock much lower.  Another approach is to wait for confirmation of this belief.

So, the way to handle this sort of setup is to (1) wait for the candlestick to come back inside of the bollinger bands and (2) make sure there are a few inside bars that do not break the low of the first bar and (3) short on the break of the low of the first candlestick.

Based on reading these three requirements you can imagine this does not happen very often in the market, but when it does, it’s something else.  The below chart depicts this approach.

 

                                                                                                                                                                Bollinger Bands Gap Down Strategy

Now let’s take a look at the same sort of setup but on the long side.  Below is a snapshot of Google from April 26, 2011.  Notice how GOOG gapped up over the upper band on the open, had a small retracement back inside of the bands, then later exceeded the high of the first candlestick.  These sort of setups can prove powerful if they end up riding the bands

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