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Each specific market has specific designed trading strategies. Whilst creating a trading system, the trader will configure the settings (chart timeframe, indicator etc.) of the trading system accordingly, that is most suitable in the market. This suggests that each trading system has the appropriate default settings for that specific market, and if the trading system is going to be traded on different markets then these settings are adjusted accordingly.

Applying a Theory by using Bollinger Band and Stochastic

As we have already highlighted in the aforementioned, price action is the best indicator, as well as the need to also determine which timeframe and indicator settings mostly adapt and identify with our trading system. Overall we must have a perfect combination of these three to get the best possible result. The speed and price momentum are identified by the Stochastic indicator and acquire a possible price trend alongside with the Bollinger band which automatically detects the volatility measurement. I will go through a few illustrations below, however, I won’t reveal my secret formula. Keep in mind, there are numerous combinations which exist, some of which function most effectively in a specific timeframe, indicator setting and specific security.

Interpretation – Bull and Bear trade setups

It has been discovered that selling the breaks of the higher Bollinger Band is a way to take advantage of overbought conditions. Typically, once a higher band has been broken due to heavy buying, the price of the security will revert back below the higher band and head toward the middle band. I based my strategy on this theory, but I will use the Stochastic indicator as a trigger line to confirm my trading setup.

Interpretation: If the price action (bullish candlestick) closes above the upper Bollinger Band, which I consider to be the first signal, we can then move towards the Stochastic oscillator and wait until it breaks the 80 level to the downside. Once the break has occurred a short position can be taken, with a potential move towards the middle Bollinger Band. Simultaneously, we place our stop loss above the shadow of the candle which closed above the upper Bollinger Band. After withdrawing 75 percent of the profit, the stop loss can be adjusted to breakeven (in case the price turns against the trader). As the price starts to pull away from the middle Bollinger Band, and the price has penetrated the lower Bollinger Band, the remaining profit can then be withdrawn. Thus from the above example we have identified that the close price is of great significance when working with Bollinger Bands.

 

Using, Bollinger Band, Stochastic, Along, Price Action, Technical Analysis, fx trader, forex UpperFig 1. UPPER

In the inverse situation we anticipate for a bearish candle to close below the lower Bollinger Band. Subsequently, when the Stochastic breaks above the 20 level, a long position can be entered, with a potential move towards the middle Bollinger Band, which is considered to be the first target. Consequently we are left with two options, to either close all positions or withdraw the 75 percent profit. If the second option is selected, the stop loss must then be positioned to breakeven when the price starts to pull away from the middle Bollinger Band. The remaining position should be closed when the price reaches the lower Bollinger Band.

In the first example below (Figure 2), let’s assume that we entered the market long at 1.2550, when the price evidently closed below the lower Bollinger Band and the Stochastic had exited the 20 level. Following that action, the price started to rise and reached the middle Bollinger Band around the 1.2630, our first target, following three positive candles. Moreover, the price continued moving to the upside and reached the upper Bollinger Band after six candles.

In the second example (Figure 2), the price managed to close below the lower Bollinger Band and slightly below the 1.2400 region. Consequently, the confirmation came from the Stochastic oscillator, which crossed above the 20 level, thus a long position can be entered. Following this setup, the price surged forming four consecutive winning candles and reached the first target (middle Bollinger Band).

Having locked the 75 percent of profits, the stop loss should be adjusted to breakeven in the event that the price moves against the trader. Subsequently, there was a pullback after the price tested the middle Bollinger Band, failing to break below the lowest shadow of the first candle, the one which closed outside the lower Bollinger Band. Instead, it started moving upwards again and after eleven candles it successfully reached the second target, meeting the upper Bollinger Band.

 

Using, Bollinger Band, Stochastic, Along, Price Action, Technical Analysis, fx trader, forex LowerFig 2. LOWER

Conclusion

As I have discussed throughout, Bollinger Band should not be applied as a signal generating indicator, but rather in conjunction with an alternate indicator in which it proves to be extremely helpful. Thus, I prefer to use Bollinger Band and Stochastic collectively to generate possible buy and sell signals as well as to identify overbought or oversold areas. Furthermore it is important to emphasize that the most essential trading technique is the price action, which allows me to read the market and make informed trading decisions based on the actual price movement, rather than relying on a single indicator. There are numerous Bollinger Band and Stochastic strategic techniques, some of which work in the short-term, others in the long-term, but never one that is long-lasting.

Efthivoulos Grigoriou
Head of Global Research and Analysis
www.jfdbrokers.com

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