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Bollinger Band Squeeze Trading Strategy

There is an infinite number of stocks to buy and sell. So, how do you decide which are the best stocks to buy and to sell? Most important, when is the correct time to buy or sell?


The Bollinger Band Squeeze is one of the numerous technical trading strategies available to help identify stock consolidations with decreasing volatility. This strategy does not have a bullish or bearish bias tilt. It is a neutral trading strategy that identifies stocks that are nearing breakouts or breakdowns.


Bollinger Bands is a technical indicator developed by John Bollinger. It measures the volatility and the overbought or oversold levels of a security or market in question. The objective is to alert the trader to whether the security is calm or volatile, denoted by the contraction and expansion of the top and bottom of the Bollinger Bands. There is one Bollinger Band strategy, the Bollinger Band Squeeze, that garners a lot of attention. Since the bands denote volatility, the squeezing of the band can lead to an impending change in volatility.


Bollinger Bands can help a trader to identify a stock's high and low volatility points. Changes in volatility are relatively easy to detect on the charts because stocks tend to alternate between periods of high and low volatility, like the calm before the storm. When the Bollinger Bands are far apart, volatility is high. When they are close together, volatility is low. A Bollinger Band Squeeze occurs when the bandwidth between the top and bottom of the Bollinger Bands reaches a six-month low level. The squeeze is based on the premise security experiences periods of alternating high volatility followed by low volatility and vice versa. A security that trades at a six-month low level of volatility via an extreme contraction in the bands signals an impending explosive breakout or breakdown.

The formula for the Bollinger Band Squeeze trading strategy divides the difference between the upper band and the lower band by the closing price, which shows bandwidth as a percentage of the price. The bandwidth is set to be narrow enough or less than 4% to capture the optimal results. Setting it too high of bandwidth can lead to too many results. Setting it too low can lead to few results.


Although the Bollinger Band Squeeze can identify these trading conditions, traders also need to deploy other technical indicators and strategies to confirm the breakout or breakdown. Trading before the actual breakout or breakdown can improve the risk-reward profile, but there is no guarantee for a successful trade. Identifying a list of stocks is often the first step of the due diligence process before the final stock selection.


Regardless of which technical screens you favor, most technical trading systems work best if they are kept simple. Simplicity should be a primary goal of any trader, whether experienced or novice. Unnecessary complexity will only confuse and needs to be avoided.


Selecting the right stock is just one part of the investment/trading equation. Identifying the right time to buy and sell is also critical to successful trading.


The Bollinger Bands Squeeze algorithm identified 35 S&P 500 stocks ranked by SCTR that show a sharp contraction in the Bollinger Bands suggesting the potential for breakouts or breakdowns.


Source: Courtesy of StockCharts.com

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