Bollinger Bands and Stochastic Trading Strategy

Using Bollinger Bands with Stochastics as a swing trading strategy is a smart play considering how powerful these two trading indicators can be.

With Bollinger Bands, we are able to judge the volatility of the market and know when the instrument is too far extended or when the market is in consolidation.  When price travels too far away from the middle band, usually a 20 period moving average, we should be on the lookout for the possibility of either a quick counter-trend trade or even a full scale price reversal.

Adding in the Stochastic Oscillator, we are able to have an objective view if a market is overbought or oversold.  This could indicate a possible reversal but trading oversold/overbought as a standalone trading strategy is not advised.

While using indicators as part of your technical analysis approach to trading, one thing every trader should understand is price action.  You don’t need to be an expert price action trader but letting price dictate your actions for a trade setup while technical indicators give you information, is a smart play.


How Does This Trading Strategy Work?

Every trading strategy should be simple enough that a 5 year old could explain it.  While that is a bit of a joke, the takeway is to keep things as simple as possible…..but as complex as they need to be.

Let’s take a high level look at using the Bollinger Bands along with the Stochastic as a viable trading edge.

  • When price is touching the outer lines of the Bollinger band, it may be due for a reversal, so you look for a reversal candlestick pattern to trade.
  • The middle Bollinger band line can be used as a reference line to move a profitable trade to break even or also can be used as a profit target or as a scale out area.
  • The stochastic indicator is used as a filter for the trades so we are adding some confirmation to the potential trading setup

Keep in mind that with any trading strategy the key is money management.  Ensure your position size reflects not only your stop but also a percent amount of your account that can withstand a string of losing trades.

Here are some more important details:

What currency pairs Can you trade this system with?  Virtually any Forex pair can be traded with this trading strategy.  It is also not instrument dependant

What is the suitable time frame for this trading system? For swing trading, stick to 4 hours and above.

Forex Indicators Required  Bollinger Band (settings:period 20, standard deviation 2) & stochastic indicator (13,5,5)

Is understanding price action important? Yes, ability to spot reversal candlesticks – dojis  inside bars, bearish and bullish harami, shooting star, hammer etc.

( If you cannot see this chart clearly, click to enlarge)

Trading Rules

To Buy:

  1. Price must be touching the lower Bollinger band line (and may close below it )
  2. Stochastic indicator is to be below 20 or just leaving that zone (oversold condition).
  3. Closing candlestick – is it a good bullish reversal candlestick? What you need to look for a bullish reversal candlesticks like, hammer, inside bar(or bullish harami formation).
  4. Once you see a suitable bullish reversal candlestick pattern, play a pending buy stop order 2-5pips above the high of that bullish reversal candlestick pattern.
  5. Place your stop loss in relation to some type of price structure or using the Average True Range indicator to set you stop

For take profit target options, here are couple of options you can use:

  • Middle Bollinger band line can be used are you take profit target, once price reaches it, you exit your profitable trade.
  • Middle Bollinger band line can also be used as a “Take Profit Target Level 1” meaning can close half (or whatever amount) of your trade when price reaches this and you keep the rest running until price reaches the “Take Profit Target Level 2” which would be the Upper Bollinger Band Line.
  • You can aim to exit your trade when price reaching the upper Bollinger band line so when price touches(reaches) this line, you exit immediately.

Trade Management:  Move stop loss to break-even when price touches the middle bollinger band line. But you need to be aware this may not be suitable on  certain times because the price may be too close and this may cause you to get stopped out only to find out later the price moves as expected. So keep 15-30 pips distance when move your stop loss to break-even.


To find setups for selling, simply reverse the conditions for a buy


It’s Not A Bullet Proof Trading Strategy

While using Bollinger Bands and Stochastic is a fine trading strategy, there are some things you should know:

In a strong trending market, prices will be hugging the upper/lower Bollinger band lines and you may find out you will get stopped out frequently if you are looking for reversals of that trend.

When price is hugging the upper band, the market is extremely strong but that type of move will come to an end.  Often times strong markets end strongly as well.

If price is hugging the lower band, this is extreme weakness and attempting to buy a market like this can lead to consistent losing trades.

Do not enter using market orders. It is preferable to use sell stop or buy stop orders based on reversal candlestick patterns you see.  Market orders are filled at “best price” and there will be times where you will encounter slippage especially during high volatility moments such as during a news release.


Use Price Action For All Trading Signals

Even though the strategy may give you a sell signal with the trading indicators, is price action showing you any confirmation at all?

For example, if you are looking for a buy setup due to the indicators, is price action showing strength or signs of reversing from shorts?  You must understand some basic level price action trading.

By the way, you may also be interested in reading these:

This free trading resource can help you with candlestick reversals!


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