Playing the Bollinger Bands®
Playing the bands is based on the premise that the vast majority of all closing prices should be between the Bollinger Bands. That stated, then a stock's price going outside the Bollinger Bands, which occurs very rarely, should not last and should "revert back to the mean", which generally means the 20-period simple moving average. A version of this strategy is discussed in the book Trade Like a Hedge Fund by James Altucher.
Possible Buy Signal
In the example shown in the chart below of the E-mini S&P 500 Future, a trader might buy or buy to cover when the price has fallen below the lower Bollinger Band.
Possible Sell Signal
The potential sell or buy to cover exit is suggested when the stock, future, or currency price pierces outside the upper Bollinger Band.
These potential buy and sell signals are graphically represented in the chart of the E-mini S&P 500 Futures contract shown below:
More Conservative Playing the Bands
Rather than buying or selling exactly when the price hits the Bollinger Band, considered to be a more aggressive approach, a trader might wait and see if the price moves above or below the Bollinger Band and when the price closes back inside the Bollinger Band, then the potential trigger to buy or sell short would occur. This might help reduce losses when prices breakout of the Bollinger Bands for a while. However, it could be argued that many profitable opportunities could be lost. To illustrate, the chart of the E-mini S&P 500 Future above shows many potentially missed opportunities. However, in the chart on the next page, the more conservative approach might have prevented many painful losses.
Also, some traders might exit their long or short entries when price touches the 20-day moving average.
A different, and quite polar opposite way to use Bollinger Bands is described on the next page, Playing Bollinger Band Breakouts.
Next Page - Bollinger Band Breakouts
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