Continuing the few posts I want to do on basic indicators/setups that I personally use, I'd like to talk about a super effective and very simple chart setup that uses a very common indicator: Bollinger Bands . I'll reiterate that TA is never, ever, ever 100% accurate and wild cards come up that break the mold of even the most reliable setups, so keep that in mind if you decide to trade using these setups; previous results are not guarantees of future performance. Keep this in mind please and always watch out for yourself.
Quick Overview of Bollinger Bands
Bollinger Bands are a price envelope defined by a Simple Moving Average acting as a base (mid line) with upper and lower bands defined that are a set standard deviation from the mid line.
The defaults for Bollinger Bands are a baseline of 20 periods for the SMA and 2 standard deviations for the bands. You can alter these to your liking in pretty much any charting software (I don't), but if you do please make sure you know why you're making this change.
Where the 200 HMA from my previous post gives you a solid baseline of around where the market has been pricing an underlying over time, the Bollinger Bands provide you with a way to visualize more recent price volatility in a way that can provide you with some extra confirmation if you're looking for overbought or oversold conditions in an underlying. The most basic, generalized way to look at the Bollinger Bands is that the closer price gets to the upper band the more overbought it may be, the closer it gets to the lower band the more oversold it may be.
Speaking personally, I use Bollinger Bands as part of my regular charting setup but I use them 99% of the time in conjunction with other indicators and would not personally recommend using them on their own. They should be part of a suite of things you look to that can confirm or disconfirm that a trend is arising. Also keep in mind that there are dozens of different ways to use Bollinger Bands for different strategies but I'm only focusing on one here.
The D1 Total Bollinger Breakout
This setup uses standard Bollinger Band defaults using a standard Bollinger Band indicator (identical to the default one on TradingView in terms of how it works).
On the D1 time scale, you want to find a chart where the daily candle has broken out over the upper or lower Bollinger Band completely. This means that the entire OHLC candle including the wicks and body are 100% outside the price envelope .
This chart setup is incredibly reliable. I use it mostly for bearish reversal plays (selling calls against the underlying for the most part) but it works just as well for bullish reversals as well in my backtesting. Even during the COVID crash when all hell was breaking loose it still called out a bullish reversal on AMEX:SPY :
As with pretty much everything you'll see me post, I direct most of these setups toward semi-boomery large to mega-cap stocks and some limited non-memey midcaps. I invite you to take your favorite stock in this category and do your own backtesting to see how reliable this setup is before using it. Nothing is 100% in trading, but I can say that after my years of using this setup it's only ever not panned out for me one time and that was with the recent pop on NYSE:WSM that I honestly still can't wrap my head around.
How to Scan for/Use this Setup
My opinion is that the best way to use this is by having a stable of stocks you know and watch regularly where you develop a feel for the price action over time. However, to scan more widely for this setup you can use something like the built in TradingView "Top Gainers" stock screener and order by the largest percent gain. On most days there's any number of stocks experiencing this kind of pop, but that doesn't mean you want to use this on all of them. Certain stocks like biotech pennies blow over the upper band regularly but I would never in a million years short one of those things considering how quickly pump and dump groups can squeeze something up. As with anything, you HAVE TO be responsible for yourself and do your research before entering into any kind of trade, especially if you decide to go short on something.
The way I personally play this chart setup is by selling options. Massive volatility swings like those that lead to the type of setup I'm outlining here lead to higher IV on options which in turn leads to inflated options premiums. Certain options strategies also provide more defined risk than you would have with, for example, simply shorting a stock hoping for a bearish reversal. You always want to be thinking about the times where things don't go how you plan and manage your risk accordingly.
The psychology behind this is honestly fairly simple. Given the types of assets I use this strategy on, these aren't fly by night operations they're normally established companies with a broad base of investor support so a big drop down normally translates into at least a next day BTFD event as longs DCA down. Alternatively, if you are holding a stock that explodes 10% in a day, you would almost certainly be tempted to take some profits on that to reinvest to other positions you want to build up. From a psychological standpoint, these are both rational moves on the part of the market and are (in my experience) fairly reliable.
And that's it. That's the whole thing. Look for stocks where the daily candle (including the wicks) are completely outside the price envelope of the standard default Bollinger Bands (the farther away they blast the better). It's about as simple as they get in terms of setups. If you find this useful, please feel free to follow me on Twitter as well.
Comment
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As an addition to this, I've gotten some feedback that I wasn't clear enough on what the break up and break down mean in terms of direction from some traders. I assumed the pictures were enough on that so my apologies for not being clearer. To clarify:
Opening and closing above the upper Bollinger Band is an indication that the underlying is very overheated and is likely to drop back down at some point in the next few days. Opening and closing below the lower Bollinger Band is an indication that the underlying is very oversold and is likely to go back up at some point in the next few days.
Thanks to @Khaleel786 for pointing this out I hope it helps. Please again keep in mind that we're working with probabilities here on large/mega caps and there will be instances where the mold is broken. Always use proper risk management when entering into any trade and never assume that anything is a sure bet just because it "usually" is.
Bollingers are by far one of my favourite indicators to combine with others to help identify unusual price movements. Thanks for sharing.
Rohitcoool
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can you please share the setup so that I can easily download and apply.
SwingTradeAssassin
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@Rohitcoool, This is more or less just the standard Bollinger Bands in TradingView. So you can just just add it from your indicator list at the top of your chart in TradingView and select the Bollinger Bands indicator.