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Prevent Excessive Trading with Bollinger Bands

Put on your headphones and enjoy podcast ~!
Back when I was starting out, I used to find myself searching for a trade, even if my system wasn’t showing me one. It’s called overtrading. I’m sure we have all been guilty of it at some point.
My problem was I couldn’t identify the optimum time to take trades that offered the best potential. I would lose money, time and time again, as the market reversed and stopped me out.
The majority of trading systems are built around momentum, or following a trend. After all, the price has to move for us to make money, and identifying the correct place to be in (or out) of the market is the key to make promising strategies profitable.
Maybe (like me) you even threw away a system that gave good signals, but lost you money when the market is range bound?
This is why sometimes the best trade is no trade. But how do you identify when not to trade?
There are a few well documented methods for spotting periods of momentum and high liquidity. There are indicators and oscillators which show you extremes. You can even use price action or candles.
When the price is pushing these indicators towards their extremes, more often than not the price is trending.
But to truly identify whether you should be in a trade based on your favorite indicator, you need to study it, and understand its personality.

1. Jumping On Momentum

I discovered, for me to have the best chance of making profit on a trend trade, I needed to act on the momentum as it breaks away from range bound areas (or consolidation areas).
My favorite indicator to identify momentum and range bound areas is Bollinger bands.
Let me show an example of the EUR/USD 15 minute chart (see Chart 1).
Quite often traders use Bollinger bands to show when price could be about to reverse. I use it in the opposite way. I use it to tell me when to trade into the momentum, and when NOT TO TRADE.
It’s not the “holy grail”, you will get false breaks, but it keeps me on the right side of momentum more often than not. If I stick to my signals, my risk strategy, my money management, then everything will be alright.
(figure 1: EUR/USD 15 minute chart)
As you can see in the first highlighted area on Chart 1, price came back from the lower Bollinger band and formed a hammer (ish) pin candle. This suggests to me the area has been rejected quite strongly, which is confirmed as the price starts to wander into “no mans land”, within the middle of the Bollinger range.
This is when NOT TO TRADE. I stay flat when price is near the center of the Bollinger bands.
The price starts to head towards the upper Bollinger. At this point I will be using my strategy to look for breaks to be long, and sure enough it does. This is when I trade, when price is pushing into the extreme.
This is when there is liquidity and momentum.
As things progress, price once again falls back into that middle area, and it is time to sit on my hands. Yes I get twitchy fingers, but you have to be disciplined, right?
I get a false signal as price starts to push the lower Bollinger. No problem. My stops and risk take care of this.
Price once again moves to the middle area then pushes the top Bollinger. I look for a signal, and I’m in.
Chart 1 is for illustration purpose only, but it is a true representation of my strategy and thinking.

2. An Important Note

When the Bollinger bands say “trade”, personally I take the trades my strategy throws out. But for safety you can filter the idea even more.
To gain confidence with this, try only looking for the movements after a consolidation period in the center of the bands. This is when the bands start to contract.
When price begins to push the upper or lower band, is it happening AFTER a consolidation area and contraction in the Bollinger bands?
If they’ve have had time to contract, and move sideways, the price is usually building up energy.
However, if price has reversed directly from a high or low and zoomed off to the other extreme, this can be a volatile period. It’s wise to stay away from these trades until you are comfortable with the idea.
Let me show an example of a 15 minute GBP/USD chart (see Chart 2)
(figure2:15 minute GBP/USD chart)
You see a steady decline at the beginning of the chart, which is pushing the extreme of the lower Bollinger band. Then price begins to move towards the center, and the bands begin to contract. The direction is undecided, and is shown by the sideways nature of the bands.
The price then starts to push on the extremes, but gives out some false signals. Personally, I would have been stopped out for small losses. No problem.
But the best trade is to wait until the bands open up a little, when price is pushing the extreme.
This is just what happens afterwards. The Bollinger bands begin to open up, and price pushes the highs. This is a good time to be looking at your system for long trades.
So now you can see when I do, and when I don’t trade. It’s nice to sit on my hands now and again. And my money is safely tucked up in my account, rather than liquid in the market for others to take advantage of.
(Author:Carl Croft)

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