What are Bollinger Bands reversal patterns?
Hi traders, in this article, I will feature a few of the Bollinger Bands reversal patterns that I personally use very often in my trading. These are valuable trading ideas that you can incorporate into your own trading strategies.
Before I jump into details, let me say this…
I always encourage traders to conduct proper backtesting when introducing new tools into your trading plan.
If you wish to discover how you can seamlessly incorporate new Bollinger bands ideas into your existing strategies, I recommend reading my previous post on Forex backtesting.
Very briefly, Bollinger Bands is a tool invented by John Bollinger in the 1980s. The tool consists of one line in the center, and 2 price channel bands above and below the center line.
The center line is usually a 20-period simple moving average, and the upper and lower bands are by default a measure of price levels that are 2 standard deviations from the center. However, there are some extreme markets that may require different parameters, so test it yourself.
Market prices tend to bounce between the upper and lower Bollinger Bands, and this tool can be used in pattern recognition to define and clarify pure price patterns. Today I will show you a few tricks to spot Bollinger Bands reversal patterns with high accuracy.
Okay, now let’s get down to business.
1. Bollinger Bands W-bottoms and M-tops
As most of you might already know, prices rarely transit from downtrend to uptrend in one vigorous move, and vice versa. Prices will instead bounce off a support or resistance level a few times before making a full reversal move.
This process creates patterns known as W-bottom (double bottom) and M-top (double top).
What we are looking for is to see that a particular support of resistance level is weakened after at least 2 bounces before an actual reversal takes place.
When using this strategy, the lower band and upper band act as the support and resistance respectively. When used near historical support and resistance price level, this method will work even better.
Wait, there’s more… Sometimes a double top might even develop into a head-and-shoulder formation which has an even higher probability for trend reversal!
When using Bollinger Bands in conjunction with pattern recognition, your probability of success will greatly increase because the band itself is an indication of support and resistance.
The higher the price moves towards the upper band, the more overbought it has become. A double top that happens here will have high probability to reverse an uptrend into a downtrend.
The lower the price moves towards the lower band, the more oversold it has become. A double bottom that forms here will have high probability to reverse a downtrend into an uptrend.
Personally, if I see a double top or double bottom that appears in the middle of the Bollinger Band, I will usually not take the trade, because it happens in the middle of nowhere. (neither high nor low)
2. Bollinger Bands with RSI (higher low and lower high)
Another way to catch Bollinger Bands reversal signal is to combine it with the RSI indicator, known as the Relative Strength Index tool. You will find it in the indicators menu for most of your charting packages out there.
The RSI is a technical momentum oscillator that measures the speed and change of price movement. In other words, The RSI measures the strength of price movements.
It is classified as an oscillator because it oscillates between the values of 0 to 100, with above 70 being overbought and below 30 being oversold.
The RSI tool typically comes with a default setting of 14-periods, although you can adjust the parameters in order to fit into your overall trading strategy. For the method that I am showing today, the default setting works just fine.
When price is near the lower band and the RSI makes continuous higher lows, this is a sign of price reversal towards an upward movement.
When price is near the upper band and the RSI makes continuous lower high, this is a sign of price reversal towards a downward movement.
Astonishing, isn’t it? But how did that Bollinger Bands reversal work?
In order to understand this, you will first imagine the support level as a cushion. When the price came down in a downtrend and hit onto the support level, the first initial low was made by RSI indicator.
When price tested the support level for the 2nd time, RSI made a higher low than the previous one. This indicated that the downward momentum was losing strength, and a buy decision is favorable here because of the high probability of a reversal.
3. Bollinger Bands and Engulfing candles
The third and last method that I am showing today is the Bollinger Bands with engulfing candles method. I personally called it the “close above” or “close below” method.
What is engulfing candle?
If you search the internet, you may come across many different ways of defining an engulfing candle. But for me, I do not care about how other people define it. It’s not because of whether other people are correct or incorrect.
It is merely because, I only care about what I have tested and proven to work for myself. Yep, what’s most important is what works for you. Okay, now this is how I define engulfing candle…
When candle 1 is a bear candle, and candle 2 is a bull candle that closes above the open price of candle 1, I call this a bullish engulfing setup.
When candle 1 is a bull candle, and candle 2 is a bear candle that closes below the open price of candle 1, I call this a bearish engulfing setup.
Do you follow me so far?
In a bullish engulfing setup, candle 1 is the last and final bear candle in a downtrend. When candle 2 engulfed and closed above the open price of candle 1, it indicates a change in momentum from down to up.
When this setup happens at the lower band, it creates a high probability trade opportunity for buy entry.
In a bearish engulfing setup, candle 1 is the last and final bull candle in an uptrend. When candle 2 engulfed and closed below the open price of candle 1, it indicates a change in momentum from up to down.
Similarly, when this setup happens at the upper band, it creates another high probability trade opportunity for sell entry.
Using Bollinger Bands reversal to make money
Okay, I am almost done; let’s wrap up today’s lesson.
Bollinger Bands is a really useful tool that can be used for identifying trade opportunities. It is even more powerful when combined with other tools to create high probability trade setups.
When used properly, Bollinger Bands can become an important part of your overall arsenal of weapons used for Forex trading.
These are just high probability trade ideas to assist you in starting to formulate your own trading plans. You must always backtest your strategy to find out how the full trading plan stands against the test of time, before trading live account.
I recommend that you read the article on my experience with backtesting strategies before believing in any methods.
That is all for today’s post. I hope you enjoyed the article, and if you like what I wrote, don’t forget to subscribe for future updates. If you have any question regarding Forex trading, just leave a comment below or drop me an email, and I will help you with it.