What Is a Bollinger Band Squeeze?
A Band by Bollinger A situation known as “squeeze” happens when the Bollinger Bands contract as a result of less volatility. John Bollinger asserts that times of high volatility frequently follow times of low volatility.Consequently, a notable increase or decrease may be hinted at by a contraction in volatility or a narrowing of the bands.A subsequent band break marks the beginning of a new move after the squeezing play has begun. A squeeze and subsequent break above the upper band initiate a new advance.A squeeze and eventual break below the bottom band initiate a new slump.
How Do You Set Up the Indicators?
Let’s go over some important indications for this trading method before getting into the specifics. First, for the sake of example, take notice that we are using daily prices and that the Bollinger Bands are set to the default values of 20 periods and two standard deviations. These can be altered to fit the features of the underlying security or one’s trading preferences. The closing price’s 20-day SMA is where Bollinger Bands begin. Next, two standard deviations above and below this moving average are assigned to the upper and lower bands. When volatility increases, the bands move away from the moving average; when volatility decreases, the bands move toward the moving average.
Chart 1 – Bollinger Band Squeeze
An indicator for calculating the separation between the Bollinger Bands is also available. Appropriately, this indicator is called Bollinger BandWidth, or just the BandWidth indicator. It is simply the value of the upper band less the value of the lower band. Understandably, stocks with higher prices tend to have higher BandWidth readings than stocks with lower prices. If price equals 100 and BandWidth equals 5, then BandWidth would be 5% of the price. If price equals 20 and BandWidth equals 1, then BandWidth would also be 5% of price. Keep this in mind when using the indicator.
How the Strategy Works
A straightforward tactic that is rather easy to apply is the Bollinger Band Squeeze. First, search for stocks with low BandWidth levels and narrowing Bollinger Bands. BandWidth should ideally be close to the lower end of its six-month range. Second, watch for a band break to indicate that a new move is about to begin. A downward band break indicates bearishness, whereas an upward bank break indicates bullishness. Keep in mind that narrower bands don’t offer any guidance.
Chart 2 – Bollinger Band Squeeze
Chart 3 – Bollinger Band Squeeze
BandWidth Signal Recap:
- Bollinger Bands narrow on the price chart.
- The BandWidth is near the low end of its six-month range.
- rice breaks above the upper band or below the lower band.
Trading Signals
Despite the Bollinger Band Squeeze’s simplicity, chartists should at the very least use it in conjunction with fundamental chart analysis to validate signals. A break above the top band, for instance, can be verified by a break over resistance. In a similar vein, a break below the bottom band can be verified by a break below support. Band breaks that aren’t verified could fail.
Starbucks (SBUX) has two signals in a two-month period, which is somewhat uncommon, as seen in the chart below. The stock consolidated with a wide trading range following a March rise. SBUX failed to break support from the mid-March low, although it did break the lower band twice. A simple chart analysis shows a pattern like a falling wedge. It is a bullish continuation pattern because, as you can see, it developed following a rally in early March. After breaking above the top range, SBUX broke resistance to confirm the move.
Chart 4 – Bollinger Band Squeeze
Following the spike over 40, the stock entered a consolidation period once more as BandWidth dropped back to the lower end of its range and the bands narrowed. In July, a bull flag was made by the surge and flat consolidation, indicating the beginning of another setup. SBUX never broke the upper band or barrier in spite of this bullish trend. Rather, SBUX experienced a steep fall after breaking the lower band and support.
Tweaking
Chartists must employ additional technical analysis techniques to predict or validate a directional break because the Bollinger Band Squeeze offers no directional cues. Chartists might use complementary indicators in addition to fundamental chart analysis to search for indications of buying or selling pressure within the consolidation. Moving averages and momentum oscillators are useless during a consolidation since they merely flatten out with the price movement. Alternatively, volume-based indicators like the Accumulation Distribution Line, Chaikin Money Flow, Money Flow Index (MFI), or On Balance Volume (OBV) should be used by chartists. The likelihood of an upside breakout is increased by accumulation indicators, whilst the likelihood of a downside break is increased by distribution signs.
Chart 5 – Bollinger Band Squeeze
The Bollinger Band Squeeze for Lowes Companies (LOW) in April 2011 is depicted in the above chart. As volatility decreased, the bands shifted to their smallest range in months. Chaikin Money Flow is seen to have weakened in March and became negative in April within the indicator window. As you can see, CMF dropped to its lowest point since January and stayed there until the beginning of May. Negative readings in Chaikin Money Flow reflect distribution or selling pressure that can be used to anticipate or confirm a support break in the stock.
Chart 6 – Bollinger Band Squeeze
Intuit (INTU) exhibits a Bollinger Band Squeeze in September and a breakout in early October in the aforementioned sample. Observe how On Balance Volume (OBV) was rising during the squeeze, indicating accumulation during the September trading range. The likelihood of an upward breakout was raised by indications of accumulation or purchasing pressure.
Before breaking out, the stock opened below the lower band and then closed back above the band. Notice that a piercing pattern formed, which is a bullish candlestick reversal pattern. This pattern reinforced support and the follow-through foreshadowed the upside breakout.
The Head Fake
John Bollinger warns chartists of the “head fake” in his book Bollinger on Bollinger Bands. Similar to a bull or bear trap, this happens when prices breach a band and then abruptly turn around and move in the opposite direction. When prices break above the top band and the Bollinger Bands contract, a bullish head fake begins. Prices swiftly return below the top band and breach the lower band, so this bullish signal is short-lived. When prices break below the lower band and Bollinger Bands contract, a bearish head fake begins. Prices swiftly rise back above the lower band and then breach the upper band, thus this bearish warning is short-lived.
The Bottom Line
A trading technique called the Bollinger Band Squeeze is intended to identify consolidations with declining volatility. This approach is neutral in its most basic form, and the subsequent split may be either up or down. As a result, chartists need to use additional technical analysis techniques to create a trading bias that will either confirm or act before the break. The risk-reward ratio will be better if you take action before the break. Keep in mind that this article is designed as a starting point for trading system development. Make use of these concepts to enhance your trading approach, risk-reward inclinations, and individual assessments. Click here for a chart of the S&P 500 ETF with Bollinger Bands and the BandWidth indicator.
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