Bollinger bands do not need an introduction to any trader whether novice or professional and whether it is stocks or Forex or any commodities. Bollinger bands find a way to the trading charts of majority of traders even if they are not used as signal generating indicator for many, especially those who are not trading for short-term or scalping or in a market which is moving sideways.
Combining various indicators which can be complementary to each other is always good. It is like team work with complementary skill sets. Let’s try to see can Bollinger bands be used for some good entry signals with the combination of some other technical analysis indicators like Stochastic and ADX.
Bollinger bands tells about the changing volatility of the market and it is important to know about the change in volatility. The change always indicate the possibilities of some major move and we need to catch that up early.
Let’s see how can we use Bollinger bands in some of the following market situations:
1) Widening Bollinger bands: This indicates that the volatility in increasing. It also indicates the possibilities of further move in the ongoing direction. But before taking a trading position we should have a good idea of the current direction.
2) Tightening Bollinger bands: This indicates that the volatility getting less, the market is getting less volatile. d may indicate that a major breakout is on the way. But we need to analyze the direction of that possible breakout.
1A) Widening Bollinger Bands with possibilities of further upward move i.e. bullish:
– The bands are widening with the upper band moving sharply upwards and the lower and moving sharply downwards.
– The price-action is moving upwards above the middle band.
– The recent candle sticks are longer than the previous candlesticks
Checklist and action:
– RSI (Relative Strength Index) is in the range of 30 to 50 and rising.
– You may also check if ADX (Advance Directional Index) is rising towards 25 and/or beyond 25 and +DI line is crossing -DI line upwards.
– Also check if Slow Stochastic is crossing the stochastic signal line upwards.
– With all the above taking place, we can expect a further upward movement. It will better to wait for 2 or 3 more candles to confirm the trend and then take a long (buy) position. There is always a possibility that before a further upward move, a downward correction may take place. The wait of 2 or 3 candles may help in increasing our profits if we can take a position during that correction and market moves as we expected. In case the market does not behave the way we expected and moves opposite, this wait will help in reducing the loss.
If ADX does not move above 25 then the upward move may be limited and hence the profit taking will be limited
1B) Widening Bollinger Bands with the possibilities of further downward move i.e. Bearish:
– The bands are widening with the upper band moving sharply upwards and the lower and moving sharply downwards.
– The price-action is moving downwards below the middle band.
– The recent candle sticks are longer than the previous candlesticks.
Checklist and action:
– RSI (Relative Strength Index) is in the range of 55 to 75 and is falling.
– We may also check if ADX is rising towards 25/beyond 25 and -DI line crossing +DI line upwards.
– Check if Slow Stochastic is crossing the signal line downwards.
– With all the above taking place, we can expect a further downward move. It will be safer and hence better to wait for 2 or 3 more candles for confirmation of the trend before taking a short position. It also happens that before a further downward move there may be some upward correction and the wait of 2 or 3 candles may help in increasing the profits or reducing the losses if we can enter during the correction, as mentioned in point 1-a.
If ADX does not move above 25 (market not trending) then the downward move may be short-lived and hence the profit taking will be also be limited.
2A) Tightening Bollinger bands (Bullish):
The pattern happens with a prolonged sideways move with less volatility (short candlesticks)
Checklist and action:
– Check if there are minimum 2 continuous bullish candlesticks (green) which are longer than previous 2 to 3 candlesticks.
– Relative Strength Index (RSI) is in the range of 30 to 50 and rising.
– You may also check if ADX (Advance Directional Index) is rising towards 25/beyond 25 and +DI crossing -DI upwards.
– Check if Slow Stochastic is crossing the signal line upwards.
– If all above are taking place then we can expect an upward breakout. It will be safer and hence better to wait for 2 or 3 more candles for confirmation before taking a buy position with a red candle.
If ADX does not move above 25 (market not trending) then the upward move may be short-lived and hence the profit taking will also be limited
2B) Tightening Bollinger bands (Bearish):
The pattern happens with an extended sideways move and also with volatility being less (short candlesticks).
Checklist and action:
– Check if there are minimum 2 continuous bearish candlesticks (red) which are longer than previous 2 to 3 candlesticks.
– Relative Strength Index (RSI) is in the range of 40 to 60 and falling.
– You may also check if ADX (Advance Directional Index) is rising towards 25/beyond 25 and -DI crossing +DI upwards.
– Check if Slow Stochastic is crossing the signal line downwards.
– If all above are taking place then we can expect a downward breakout. It will be safer and hence better to wait for 2 or 3 more candles for confirmation before taking a sell position with a red candle.
If ADX does not move above 25 then the upward move may be limited and hence the profit taking will be limited.
3A) Continuation of uptrend after correction during the ongoing trend
Correction always takes place even during strong trends. During an uptrend the price may reverse to the middle band or even towards the lower band.
Checklist and action:
– RSI (Relative Strength Index) is in the range of 30 to 50 and rising.
– We can also check ADX (Advance Directional Index) to see if the ADX is above 25 and +DI line is over -DI line (bullish configuration).
– Whether the Slow Stochastic is over the signal which indicates a bullish configuration.
– With all the above we can expect the continuation of the ongoing uptrend. It is safer and better to wait for 2 or 3 more candles to have a confirmation that the recent opposite move was just a correction and then take a buy position
3B) Continuation of downtrend after correction during the ongoing trend
Correction always takes place even during strong trends. During a downtrend the price may reverse to the middle band or even towards the upper band.
Checklist and action:
– RSI (Relative Strength Index) is in the range of 55 to 75 and falling.
– We can check ADX (Advance Directional Index) to see if the ADX is above 25 and -DI line is above +DI line (bearish configuration).
– Whether the Slow Stochastic is below the signal line which indicates a bearish configuration.
– With all the above we can expect the continuation of the ongoing downtrend. It is safer and better to wait for 2 or 3 more candles to have a confirmation that the recent move in opposite direction was just a correction before taking a short position.
Note: We have mentioned Slow Stochastic. Some traders use normal stochastic, some “slow stochastic” and some “full stochastic”. Normal stochastic oscillator may tend to give too many false signals and full stochastic need a decision as to how slow we want to make it. I generally use either the normal stochastic with default settings or the slow one. Depending on the strength of the trend and market situations we can decide to use full stochastic and the factor as to how much slow we wish to make it.
You may check more details about Bollinger Bands at Forex Trading site ForexAbode.com