Discover John Bollinger’s Bollinger Band Rules for Successful Trading

DLMvn > Trading Indicators > Discover John Bollinger’s Bollinger Band Rules for Successful Trading

Based on 30 years of experience using the Bollinger Band indicator, John Bollinger and his associates have formulated several highly valuable rules that you can apply in stock trading. These rules not only help you gain a deeper understanding of how the Bollinger Band works but also provide an effective method for analysis and trading.

Rule 1: Bollinger Band Provides a Relative Definition of High and Low Prices

Bollinger Band helps us identify high and low price levels in the market relatively. When the price touches the upper band, the market may seem “too high,” and conversely, when the price touches the lower band, it could signal that the market is “too low.” But is this always true? Not necessarily, as the market can maintain this state for an extended period if there is enough momentum from buyers or sellers.

Rule 2: Use Relative Rules to Make Buy and Sell Decisions

When using Bollinger Band, it is important not just to look at the price levels but also to compare them with other indicators such as momentum or trading volume. This helps you make more accurate and grounded buy and sell decisions. However, it is also important to note that these signals will not always lead to success. The combination of indicators requires careful consideration, avoiding excessive reliance on any single factor.

Rule 3: Combining Indicators

Bollinger Band can be combined with other indicators such as RSI, MACD, or volume indicators. However, this does not mean that any indicators can be combined arbitrarily. DLMvn particularly advises against using similar indicators in the same strategy. For example, two similar momentum indicators may sometimes reduce the accuracy of the trade signals and may not always produce the expected results.

Rule 4: Signals from Price Patterns

Bollinger Bands are also very useful in identifying classic price patterns such as the M and W patterns. However, simply identifying a pattern is not enough; you need confirmation from other indicators or candlestick patterns before executing a trade. A key point to note is that price patterns do not always play out exactly as the theory suggests, so avoid rushing into decisions without additional confirmation.

Rule 5: Signals from Price Exceeding the Bollinger Band Range

According to DLMvn, one common misconception is that when the price breaks above the upper band, it signals a sell, or when the price breaks below the lower band, it signals a buy. In reality, this is not the case. Price breaking out of the Bollinger Band range is often a sign of a strong continuing trend, not a reversal. This is especially evident in strongly trending markets, where the price tends to continue in the current trend after breaking the Bollinger Band.

Rule 6: Using Bollinger Band in Trending Markets

In a clearly trending market, the price may stay close to the upper band if the trend is strongly upward, or near the lower band if the trend is strongly downward. However, if you are trading in a sideways market (a range-bound market), the signals from Bollinger Band may be less effective. Therefore, in strong trends, Bollinger Band is truly an extremely effective tool to help you identify appropriate entry and exit points.

Rule 7: Adjusting the Bollinger Band Parameters

The default parameters of Bollinger Band (20-period MA and 2 standard deviations) are only reference values. Depending on the market and specific trading strategy, you can adjust these parameters to suit your needs. For example, in highly volatile markets, you may change the standard deviation parameter from 2 to 2.1 to make the Bollinger Band more accurately reflect the strong market fluctuations.

Rule 8: Using Bollinger Band on Different Time Frames

Bollinger Band can be applied on various time frames, from M5 (5 minutes) to weekly charts. However, it is important to have enough price data to paint an accurate picture of support and resistance levels. DLMvn recommends using larger time frames when analyzing long-term trends and smaller time frames when trading short-term moves.

Tip: If you are trading in strongly trending markets, do not focus too much on short-term signals. Instead, focus on the long-term trends that Bollinger Band helps you identify.

Rule 9: Enhance Knowledge of BandWidth

The BandWidth indicator helps you identify the width of the Bollinger Band, thus aiding in decisions about the continuation of trends. When BandWidth expands, it is often a sign of a strong trend, and when BandWidth contracts, you may be near an accumulation or reversal point. Changes in the width of the Bollinger Band are signals that you should not overlook when monitoring the market.

In-Depth Analysis of Bollinger Band and Challenges to Consider

Bollinger Band is one of the most widely used technical analysis tools in stock trading. However, to use this tool effectively, you need to have a clear understanding of how it works and the factors influencing the signals it provides. While it has many strengths, Bollinger Band also has limitations that you need to consider carefully.

1. The Relative Nature of Bollinger Band

One of the most important aspects of Bollinger Band is its ability to determine high and low price levels in the market, but this is a relative indicator. This can be confusing if you do not fully understand how it works in different market conditions. For example, in a highly volatile market, when the price touches the upper band, it may just indicate the continuation of an upward trend, rather than an overbought signal.

Furthermore, Bollinger Band cannot provide a “perfect signal” for overbought or oversold levels. If used alone without confirmation from other indicators, you may face high risks. This is why DLMvn always recommends combining Bollinger Band with other indicators such as MACD or RSI to get clearer signals.

2. Theory vs. Reality

One of the points often overlooked when using Bollinger Band is its inaccuracy in identifying reversal patterns. In theory, when the price breaks above the upper band or below the lower band, it can be seen as a sign of a reversal. However, in reality, these price levels often signal a strong trend continuing. For instance, in the case of the U.S. stock market in 2020, when the Dow Jones reached its peak in February and consistently broke above the upper Bollinger Band, interpreting this as a sell signal was entirely wrong. In reality, the price continued to rise sharply before dropping in Q1 of 2020 due to the impact of the COVID-19 pandemic.

Therefore, DLMvn wants you to understand that Bollinger Band signals need to be cross-checked with macroeconomic conditions and specific market factors. Do not apply theory rigidly.

3. Bollinger Band in Sideways Markets

An important factor to consider when using Bollinger Band is its application in sideways (range-bound) markets. In these periods, the market lacks a clear trend, and the price fluctuates within a narrow range, causing the Bollinger Band to continually narrow. This can lead to wrong decisions if you do not realize that the market is not yet showing a strong breakout.

Certainly, some traders may take advantage of sideways periods to scalp by buying at the lower band and selling at the upper band. However, this strategy is not always effective, and if you are not patient, taking early profits or ignoring signals will lead to losses.

In markets with no clear trend, you need to change your approach when trading with Bollinger Band. Instead of relying solely on signals from the upper and lower bands, pay attention to changes in BandWidth and %B to look for potential breakout signals.

4. Challenges When Adjusting Bollinger Band Parameters

One issue many investors face when using Bollinger Band is adjusting the moving average (MA) and standard deviation parameters. It is easy to notice that when you change these parameters, you will receive different signals. However, adjusting parameters is not always straightforward and does not always bring the expected results.

In fact, using the default parameters (MA 20 and standard deviation 2) is reasonable for most markets, but for specific markets like indices of developing countries or stocks with high volatility, you may need to experiment with different values to ensure more accurate signals. DLMvn recommends starting with the default parameters and experimenting with others when necessary.

5. The Relationship Between Bollinger Band and Other Indicators

A major question many traders ask is whether they should use Bollinger Band on its own or combine it with other indicators like RSI or MACD. The answer is: it depends on your trading strategy. If you are trading short-term or scalping, combining Bollinger Band with RSI to identify overbought or oversold levels may be effective. However, for long-term strategies, you need to view these indicators in the context of the overall market, rather than focusing solely on the short-term signals provided by Bollinger Band.

Thus, while Bollinger Band provides extremely useful signals for trend identification and trading strategy adjustments, it is not a magical tool. Using Bollinger Band requires deep understanding and a keen awareness of various market conditions. Remember, when trading stocks, patience and market observation are the keys to success.