Today I am going to explain a profitable trading strategy based on using the Bollinger Bands as a momentum style indicator. The purpose of this strategy is to use the Bollinger Bands to generate trading signals designed to capture powerful breakout price moves and to capitalize on the resulting trends from these breakouts.
The Bollinger Bands are often used for the purpose of generating signals to determine when price is entering over-sold or over-bought areas on the chart, relative to recent price. This strategy utilizes the Bollinger Bands in a completely different way – to identify breakout trade opportunities which often lead to price trending in a defined direction for an extended period of time.
By definition, all price trends must begin with a breakout from a range. There are many different ways that we can identify and quantify price ranges. As we know, the Bollinger Bands consist of an upper and lower band which are plotted two standard deviations on either side of a 20-period simple moving average (20SMA). For the purposes of this strategy, the range that we are going to use to generate breakout signals is the range between the upper and lower bands of the Bollinger Bands.
The Bollinger Bands range will expand and contract in relation with the volatility of price. For this reason, we also are going to consider the Bollinger Bands Width (which is a separate technical indicator, available on reputable technical analysis platforms) as part of this strategy. When we observe price breaking out from the Bollinger Bands range, we are going to look for the Bollinger Bands Width expanding as a confirmation of volatility increasing meaning that we have a higher chance of experiencing a sustained breakout move.
Finally, we want to ensure that we are always trading in the same direction as the current trend of the market. To do this, we are going to add a 200 period exponential moving average (200EMA) to our chart. When the 200EMA is pointing higher, we are only going to take signals to go long (buy breakouts above the upper band). Conversely, when the 200EMA is pointing lower, we are only going to take signals to go short (sell breakdowns below the lower band).
Our signal to sell, when trading this strategy, comes when a candle closes on the other side of the middle line of the Bollinger Bands. We must also ensure that we have adequate risk management measures in place to limit the maximum size of our losing trades. To do this, we are going to implement a stoploss directly below the lowest point of the candlestick from which our buy signal has been generated, or the candlestick prior, whichever is lower.
Let’s summarise our entry and exit signals for this strategy:
1. A candle breaks out and closes outside of the Bollinger Bands Range.
2. The 200EMA is trending in the same direction as the breakout.
3. The Bollinger Bands Width is expanding.
1. A candle closes on the other side of the middle line of the Bollinger Bands.
2. Our stoploss is triggered.
Figure 1: Bollinger Bands Momentum Strategy
If you are more of an intermediate or experienced level trader, consider adding the following conditions to further enhance your results from trading this strategy.
1. Do not buy directly below a resistance level or sell directly above a level of support.
2. Implement additional momentum style technical indicators (such as the MACD) to confirm entry signals.
3. Make use of a trailing stoploss to lock in profits as price trends in your favour.
This trading strategy has been tested across multiple different timeframes and trading markets.
If you would like to view my backtested results from this strategy, check out my video at the following link: