Bollinger Band Squeeze Breakout Strategy

The Bollinger band indicator is a great way to measure the volatility of any trading instrument.  Using an upper band and lower band set X standard deviations (generally 2) away from the center moving average ( generally the 20 period), we can see when an instrument is at an extreme price as well as when the volatility has increased or decreased.

The breakout strategy will use the Bollinger Band “squeeze” together to alert traders to a market that is compressing.  From compression, we eventually see a breakout trading opportunity.

That is exactly what we want to capitalize on as a means of entry into a swing trade.

The Bollinger band squeeze swing trading system is a very simple trading system that is easy to implement.  This article, Using Bollinger Bands, will give you more insight into this indicator.  If you are not familiar with Bollinger Bands, please read that first and then come back.

Looking For Bollinger Bands Squeezing Together

One of the main characteristics of a Bollinger band is that it becomes narrower as price volatility decreases, with price moving sideways and in a tight range.  You can call it  the “Bollinger band squeeze.”

When the Bollinger Bands are wide, we are looking at a market that is volatile with moves that we can trade.  Keep in mind that what goes up must come down and the bands getting wider indicates the potential for the first thing we need to happen for our Bollinger Breakout system.

The feature we are looking for is the squeeze portion which is highlighted “squeeze” – when the Bollinger Bands narrow.  We don’t know when the squeeze will happen so you do have to continually scan your charts for this portion of the system.

Once we see the squeeze happen with the Bollinger Bands, we know that a breakout to the upside or downside will eventually occur.  The thing is, we don’t know when it will happen.

We also don’t know which direction the break will come.

You can monitor price action in order to trade any directional move from the Bollinger Band squeeze or you can choose to simply trade in the direction of the predominant trend.

Price Breakout From Bollinger Band Squeeze

Sine the Bollinger Bands are, in theory, encompassing 90% of normal price action, any break out of the Bollinger Bands is a “that’s different” event.  From those events, we can find an opportunity.

In the following chart, we have price in a downtrend and the wide Bollinger Bands narrow indicating lower volatility in price – the “squeeze”.

You don’t want to trade just “any” price movement as the Bollinger Bands are not a standalone trading system.  Using basic technical analysis and price action, we can improve our odds trading the breakout but as always, in trading, nothing is ever perfect.

We are using standard technical analysis tools – horizontal support and resistance and trend lines.

1. The Bollinger Bands have begun their squeeze as price starts to range after a move down in price.  Price action begins to hug the middle moving average which further indicates ranging price action.  After several bounces up and down, we are able to draw our support and resistance lines
2. Price puts in a lower high so we are able to draw a down trend line.  Remember, we are looking to trade short as indicated by the previous trend in price.
3. We see a breakout to the downside of the Bollinger Bands and while you could sell the break, it is not a high probability trade
4. As price usually does, we have a breakout and a pullback which coincides with the moving average between the upper and lower bands, hits the trend line and the bottom of the support zone.

These setups will look different each time but if you understand support and resistance and how to draw a trend line, you should be able to trade them.

Trade Exits:  Stop Loss and Take Profit

You should never trade without a stop loss.  On that note, trading with a tight stop loss is almost just as bad as you will get flushed out of your trade on a false breakout in the opposing direction of your trade and then watch price sail in your direction.

There are many ways to place a stop loss and some are more objective than others.

• You can place your stop loss X number of pips away from the opposing side of the Bollinger Squeeze.  Too close and you can get whipsawed out from a breakout that turns, takes your stop and then breaks out again and continues to move.
• You can use the Average True Range (ATR) and use a multiple such as 2 X ATR for your stop.  This should keep it out of the day to day noisy price movement in the market.  If your stop starts to get challenged, you may opt to cut the trade short and then look to re-enter because a true breakout, should not challenge a 2 X ATR stop.
• In the above example, traders may be tempted to use the swing high at #4 but that looks too close and you could get spiked out of your trade in the zone that is the traders action zone.

Is This Breakout System Just For Swing Trading?

Virtually any trading system or trading strategy can be used for any type of trading.  In Forex, I prefer swing trading due to the many news releases that happen every day.  I like my trades to be larger in scope with the chance of great returns.

That’s not to say you can’t day trade or scalp using the Bollinger Band squeeze breakout, just know that the larger time frames can offer higher returns.

If you do want to try this strategy for day trading or a faster time frame, I would suggest using a lower moving average such as a 10 period.  This will obviously set your upper and lower bands closer to price action but with any trading indicator, don’t get too caught up in finding the best setting – they don’t exist.